Investment as Usual is Broken [Part 1 of 3]: Valuing ESG factors in equity analysis

Investment as usual is broken. The emergence of environmental, social and governance [ESG] factors in the twenty-first century has challenged the core of business thinking and strategy. Corporations are changing, sustainability has risen to the level of the C-suite, P&G recently appointed their first “Corporate Sustainability Officer”. But the “Chief Sustainability Investment Officer” is much further off. WSJ covers this amongst other "title inflation" items in Dec

Enhancing current investment analysis by integrating material ESG factors will offer better pricing of future risks and opportunities.

Global financial stock now stands at US$140 trillion and growing, according to McKinsey, 2007 based on the latest 2006 data. The value of total global financial assets—including equities, government and corporate debt securities, and bank deposits—expanded to US$140 trillion by the end of 2005, an increase of $7 trillion from a year earlier . But many of the investment decisions are being driven by decision-makers who completed their studies before Google, more influenced by Gordon Gecko of “Wall St” than Al Gore! The sea-change in the way corporations are facing up to our changing world has yet to catch up to the inertia of investment professionals on Wall St, in the City of London and other major investment centers. Investment as usual fails to integrate ESG factors properly. I'm more open for entertainment though - word is there's an update to Wall St, and heck in the past 20 years, cannot say there's no material.

It has become accepted wisdom that “business as usual” will inexorably lead to humans consuming more than the carrying capacity of this one earth’s natural resources, from fossil fuels to potable water to clean air. Investment as usual – the practice of investment management - needs to make a similar adjustment as companies are making in assessing a sustainable future. Matthew J. Kiernan, founder of Innovest Strategic Value Advisors, says traditional financial analysis captures only a quarter of a company's risk and competitive profile. Risk-adjusted returns must reflect a broad and long-term understanding of materiality, within the bounds of fiduciary duty and applied across portfolios and asset classes.

In July, 2007, the United Nations Global Compact annual event keynote address was made by Goldman Sach’s Anthony Ling on behalf of the financial community . It is also true that Hermes has led an engagement on iron and steel companies in the Brazilian supply chain slave labour case. Goldman Sachs presents ten reasons for incorporating ESG factors, three of which were i. experience with risk and return balance, meeting liabilities including identifying global social and environmental challenges, e.g. secure energy supply, climate change, water shortages, BRICs growth, and increasing awareness of ESG issues by analysts and investors. The Goldman Sachs analyst team based in London released a 179-page equity research report titled "GS Sustain" in which it recommended 44 companies based on a combination of companies' ESG performance and fundamentals.

Goldman argued that its picks based on this formulation, both in the U.S. and abroad, outperformed the Morgan Stanley Capital International World Index by 25% over the past two years. A neat approach to selling the quality of your investment ideas. It has been wonderful to watch the London-based team grow from just 2 in 2005, to about 8 now, with more attention from institutional investors than even the GSAM itself. There's an old legend about leaving to find you way, and getting respect in foreign lands, no? Abbey Joseph Cohen will be interviewed by Maria Bartiromo on WSJR next week, maybe it will come up and give the initiative a push...

A recent report by McKinsey indicated investor community ranked only ninth amongst factors leading corporate managers to address societal concerns now and in the next five years. CEOs ranked employees as the stakeholder group that has the greatest impact on the way companies manage their societal expectations. The 391 CEOs surveyed representing 230 organizations in Private/Public, State-owned & NGOs. 90% of company CEOs participating in the United Nations Global Compact said they are doing more than they did 5 years ago to incorporate ESG factors into their strategies. Socially irresponsible business practices might make it harder for companies to attract and retain talented people.

But where is the voice of the investor?