The time has come to replace the question 'how much return?' with 'how much sustainable return?' There are compelling reasons why one will be better off owning sustainable businesses or businesses that equally prioritise profits, people and the planet.
Take the case of when a US court ordered Johnson & Johnson to pay $72 million in damages for an ovarian cancer death linked to the use of its baby powder or when Nike was accused of deploying child labour in the production of its soccer balls in Pakistan.
There are many more examples - when the local government revoked Coca-Cola India's licence to operate and ordered the company to shut down its $25 million plant due to the groundwater depletion it was causing or when India's biggest-ever corporate accounting scandal at Satyam came to light or when Benetton, Primark, Walmart faced severe criticism and protests for the Dhaka garment factory collapse or when the Obama administration billed BP $69 million for the clean- up of its oil spill.
Phew, the list can go on and on.
We observe that when businesses fail to consider the long-term, comprehensive impact of their actions on investors, communities and ecosystems, and focus only on short-term profits, they increase the risk of severe incidents, regulatory actions and litigations.
This, in turn, leads to major expenses to undo or compensate for the ensuing mess. They thus get distracted from concentrating on their core competency and spend valuable resources to defend their actions. This lack of foresight on risk and responsibility management eventually translates into lower profitability and valuation.
Let's see how. Over the years, India Inc. has had many instances of stock price reactions to negative developments, and you as investors have had to deal with the consequences.
Notice how the above environmental, social or governance (ESG) related aspects, seemingly non-financial in nature, ultimately have financial consequences, adversely affecting either earnings or share prices of the business in both, the immediate and the long term.
With the Insolvency and Bankruptcy code to scrutinise corporate defaulters, Personal Data Protection Bill that intends to prioritise privacy and data security, empowered consumer grievance redressal forums, labour unions, media and growing awareness of environmental degradation, unless the company is rooted in sound ESG practices, its survival will eventually come into question.
As a business owner/investor, this should definitely concern you.
If you're still not convinced, here are some examples of how ESG-compliant companies can be expected to significantly outperform their peers over the long term.
Berger Paints with its environmentally friendly products (E), providing rural women employment (S) and professional management despite promoter holding of nearly 75 per cent (G) enjoys better valuation than competitors Asian Paints, Kansai Nerolac and Shalimar paints.
The stock price of Marico with five out of nine Board members independent (G) and 37 per cent of the raw material sourced from renewable sources (E) trades at a premium multiple compared to HUL and Dabur.
And Shree Cement with its plants that comply with lower emissions and zero liquid discharge norms (E), and environmentally and socially sound contracts with suppliers (S) has been rewarded more by financial markets in comparison to its competition Ultra Tech and Ambuja Cement.
At the end of the day, successful investments depend on a booming economy, which depends on healthy people, who are ultimately dependent on a sustainable planet. In the long-term, therefore, investors have a clear self-interest in encouraging businesses with ESG compliance to survive and thrive by choosing them over the irresponsible others. No wonder then that ESG is the fastest growing investment approach globally with $ 22 trillion (nearly 25 per cent of all funds) institutional investment now branded ESG.
But for the average investor, spotting ESG risks can be challenging as these non-financial factors may not be evident in financial statements. Thus, ESG-oriented funds can help investors identify such companies that thanks to great ESG practices have lower tail risks, are less likely to go bankrupt and less likely to have large price or earnings declines. These funds do an in-depth analysis of factors such as minority shareholder treatment, board independence, labour practices, gender diversity, water stewardship and greenhouse gas emissions by studying company disclosures and interacting with management and various stakeholders.
It's 2019; responsibility and pro?tability are no longer incompatible, but in fact wholly complementary. Thus it's time you give adequate attention to the non-financial activities of the businesses you own and appreciate the upside in valuation that flows from them.
(The writer is senior fund manager at Quantum Mutual Fund)