Long-term benefits of investing in firms with good CSR

However, over the past 10 to 15 years, investors putting their money to work along ethical, moral and environmental lines have seen a strong performance, not least because they will have escaped some serious events. 

For example, those taking a strong line against oil companies will have been protected against the share price fallout from the Deepwater Horizon disaster of 2010, which led to a £47bn compensation process for BP.

From a March 2010 high of near 620 pence per share, the 20 April disaster saw the price fall to lows of approximately 319 by 1 June, according to data from the FT.

Financial benefits

Sandra Crowl, member of the investment committee at Carmingac, says there are "clear financial benefits" to investing along CSR principles.

She explains: "For example, a company that avoids environmental agency fines through best practices of soil, water and air treatment will perform better over the long term.

"Furthermore, banks are being pressured by government lobby groups, particularly in Europe, not to finance high polluting industries given the Climate Control 2030 objective.

"It is clear the laggards in managing climate control risks will be left behind. Looking beyond environmental issues, companies that value and invest in the staff will see the benefits of greater loyalty and lower staff turnover, leading to higher productivity and output."

CSR must go to the heart of the business model, otherwise it is no more than a token add-on. Matt Crossman

So when it comes to investing along corporate social responsibility (CSR) lines, the argument among proponents of CSR is that a client with high exposure to companies with good CSR track records will be less likely to suffer a series of shocks and setbacks in their portfolio due to some scandal breaking or having to shell out billions in redress.

John Ditchfield, co-founder of Castlefield Advisory Partners, comments: "The argument here is that well-run businesses will tend to recognise the importance of mitigating reputational risks through acting as a good corporate citizen."

Rose Beale, thematic analyst in the responsible investment team at Columbia Threadneedle Investments, lists the long-term benefits of investing in companies with strategic CSR and strong ESG performance as: 

• Greater likelihood of financial outperformance.
• Reduced risk and volatility.
• Reduced environmental and social negative impacts.

Ms Beale backs this up by stating: "There is a wide body of research which has recently been reviewed in a microstudy undertaken by the University of Hamburg.

"This study, the largest of its kind to date, examined ESG and corporate financial performance across more than 2,000 academic studies published since 1970 and concluded that there is a positive correlation between ESG risk management and financial performance."

Analysis

There is an old argument being that investors who want to be 'ethical' must be prepared to give up some of their performance. This argument seems to be pervasive, despite myriad studies showing this to be not the case. 

For example, according to research carried out by FE Trustnet, the average 'ethically managed' fund stormed ahead of its competitors in 2017, which was a strong year for all markets (see graph 1).

Albeit this was over a short time frame; but over the long-term, globally diverse, ethically managed funds have also provably outperformed the Investment Association Global sector peers.

For example, the Liontrust Sustainable Future Global Growth fund, which has been in the author's Isa for several years, has rarely underperformed the IA Global sector since 2013.

As at June 13, according to data from FE, the fund has returned 88.27 per cent since 2013, compared with 67.31 per cent for the Global sector over the same period (see graph 2).

The blue line on the graph below is the IA Global sector, while the orange line is the Liontrust SF fund.

Source: FE/Hargreaves Lansdown

Similar research can be easily carried out by looking at the performance figures from Morningstar against certain indices, but there are also academic studies carried out recently which suggest there is a "significant" outperformance to be gained from firms with good ratings on material sustainability issues, compared with firms that have poor ratings. 

In 2016, the American Accounting Association journal published a research paper, called Corporate Sustainability: First Evidence on Materiality. 

Written by Mozaffar Khan, Harvard University and University of Minnesota, and George Serafeim and Aaron Yoon from Harvard University, the paper argued that excellent CSR led to better returns against peer companies with poor CSR.

The paper found: "Using both calendar-time portfolio stock return regressions and firm-level panel regressions, we find that firms with good ratings on material sustainability issues significantly outperform firms with poor ratings on these issues."

That said, firms that only paid lip-service to CSR or ESG issues, and which did not put this at the heart of their business, were less likely to show such outperformance.

According to the paper: "In contrast, firms with good ratings on immaterial sustainability issues do not significantly outperform firms with poor ratings on the same issues."

Risk management

It is more than pure performance, however, as Matt Crossman, engagement manager for Rathbone Greenbank Investments and stewardship director for Rathbones, points out. 

For him, "it all comes down to risk management".

He explains: "Transparent companies are often those with a more long-term outlook, which can be trusted to focus on long-term value creation.

"Where a commitment to CSR is genuine, it can enhance a company’s reputation, boost its recruitment efforts and improve morale. In the environmental area, it can deliver concrete cost savings."

However, he is clear that CSR, or a commitment to long-term value creation, is not compatible with every business model.

"There are industries where the social and environmental impact is so great that even the best CSR programme cannot outweigh its negative effects," he says, giving as an example the tobacco industry.

Here, despite tobacco companies actively being involved in the creation of philanthropic community projects and education, often in the form of grants, scholarships, professorships, even the creation of an entire school, the very core of its business model is predicated on a product that can kill.

A recent World Health Organisation report, Tobacco Industry and Corporate Responsibility: An Inherent Contradiction, pointed out that, alongside the industry's philanthropic efforts: "The toll of tobacco-related disease and death around the world is spiralling to 4.9m lives lost every year.

"This figure exceeds all previous projections, reaching greater dimensions, faster than expected — reaffirming the urgent need for action on a global scale."

Companies having sound policies to manage the full range of risks they face makes good sense. Jennifer Walmsley

This is why Mr Crossman is clear: "CSR must go to the heart of the business model, otherwise it is no more than a token add-on".

But tobacco isn't the only sector facing conundrums with CSR; any company could technically fail to manage an environmental or social risk properly.

In this case, as Jennifer Walmsley, partner at consultancy Arkadiko Partners, explains, this "tends to give rise to the question of what else they are not managing well".

Ms Walmsley adds: "'Good CSR' is simply part of a company’s licence to operate in certain sectors such as extractives, where failure to do so has real and immediate repercussions.

"Where a health and safety incident closes a mine for a week, for example, then the financial impact of that is obvious.

"More broadly, companies having sound policies to manage the full range of risks they face makes good sense because it should, over the long term, mean that those companies are less subject to unanticipated shocks. Investors often talk about sustainability."

Regulation

Regulatory change is driving governments and companies towards a more ESG-friendly approach, and not just nationally but across the European Union and globally.

According to Stephanie Maier, director of responsible investment for HSBC Global Asset Management: "We are seeing a welcome increase in sustainability disclosure guidelines and expectations globally, whether in the form of mandatory corporate reporting or listing requirements.

"Companies failing to appropriately manage and disclose environmental, social and governance risks will see greater scrutiny from investors and regulators."

Her comments were backed up by those of Lisa Beauvilain, director and head of sustainability and ESG for Impax Asset Management.

She believes regulatory and reputational 'brand' risks of getting it wrong can have serious consequences for these companies.

Ms Beauvilain elaborates: "For investors it is important to understand the most material non-financial risks that companies are facing and how well companies manage these risks.

"Companies that manage these issues well are more likely to do well over the longer term."

Companies failing to appropriately manage and disclose environmental, social and governance risks will see greater scrutiny from investors and regulators. Stephanie Maier

For Ms Walmsley, investors should ensure companies are not ignoring long-term risks in favour of short-term growth.

She adds: "For example, it may make sense for today’s share price for a garment company to manufacture its goods in a sweatshop in a developing market. However, over the long term, that decision will damage the company’s reputation and turn consumers against it."

Therefore, companies which fail to grasp the importance and the speed of regulatory and reputational change will find themselves not only left behind by their more nimble peers, but also at the sharp end of enforcement.

Assess the client's priorities

It is important to test what a company or fund management group says, according to Thierry Bogaty, head of SRI Expertise at Amundi, because "analysing companies' CSR practices and strategies allows asset managers and investors to address specific objectives with their investment solutions".

This includes the mitigation of ESG-related long-term risks (such as climate-related risks), or the integration of opportunities (for example increasing consumers’ requirements for healthy and safe products).

By so doing, he adds, this should generate "long-term additional financial return".

While it is true that a well-run company will usually perform well financially, Anna Sofat, founder and managing director of Addidi Wealth, says it is not always as simple an equation when it comes to building portfolios.

Instead, advisers need to assess what the client really needs.

She states: "It used to be said that investing in companies with good CSR yields lower returns, because when other sectors do well, these companies automatically underperform against them.

"But it depends what your priorities are. From an environmental perspective, investing in firms that put CSR high up the agenda will ensure global problems, such as the impact of climate change, are at least addressed and checked."

Balancing the client's morals and motivations against the reality of the vagaries of the investment market is therefore vital for advisers. 

That said, Ms Sofat says: "There is increasing evidence to suggest that companies with good CSR last longer and are more financially sustainable, so in the long-term, investing in these will be more sustainable too."

simoney.kyriakou@ft.com