Product, Service & Design Innovation
Show Me the Money:
Sustainability and Financial Outperformance

“The Analytical Engine has no pretensions whatever to originate anything. Its province is to assist us in making available what we are already acquainted with.”— Ada Lovelace

At the leading edge of sustainability best practice some leading companies are already developing meaningful pathways towards truly sustainable business models. For the followers, there is perhaps a perceptible acceptance that sustainability is an important aspect of good corporate management. However, there still remains a need to demonstrate, within the current modes of capitalism, how sustainability impacts financial performance.

In our discussions with companies and sustainability practitioners within them, we often find that establishing a clear business case for sustainability is still required.

The world as it is and the world how it might be

Debates within the relatively small world of sustainability tend to have two broad areas of focus: conversations about how to achieve sustainability within the world (and system) that we have, and discussions of how sustainability might be achieved if the world were different.

As with any group of humans talking about stuff, a focus upon one of the categories above often gets derailed by participants asking why the other is being ignored. Participants in discussions about the business case for sustainability in the current economic reality are frequently told that there is simply so much wrong with capitalism as it is that ‘sustainable business’ is not only an impossibility but also an offensive term.

Conversely, utopian discussions about how the world might be and how we might get there are similarly beset by people saying that we must recognise the realities of where we are and not depart into sustainable flights of fancy.

Such is the stuff of life on the Internets.

Of course there is room and necessity for each type of effort. We won’t achieve a very different, sustainable world without dreaming big, and we also won’t establish the importance of sustainable business without proving its worth in the system we have now.

While I am happy to rail against capitalism as currently configured, I also see the need to try to map a pathway from here to there … which will in part involve using the finance and economics that we have now to create the case for sustainable change. Given this, there remains a consistent need to be able to demonstrate how sustainability makes business and financial sense now.

This post presents a quick overview of some of the available sources of evidence on how the financial performance of companies that are relatively more sustainable (i.e. less bad) compares with that of companies that are either ignorant of or in ‘opposition’ to sustainability.

Sustainability and share price performance

The focus of this information is primarily upon listed companies as indicated by their share performance as this is where the best data are freely available. That is not to say that privately held companies or those with other ownership structures will not have stories to tell, just that they are often more difficult to find.

A few disclaimers

Before supplying what I believe is a pretty decent set of evidence for sustainability aligning with good financial performance, it is important to establish some health warnings:

• Sustainability is of course not per se an indicator of business success — there are many ‘sustainability rejecters’ that sail on doing well in terms of share price and revenue.
• Disentangling cause-and-effect relationships is always difficult — therefore it is just as difficult to tell which ‘bit’ of share price performance is due to which policy, decision or happening. While it’s possible to find examples of share price dips in relation to identifiable, time-specific incidents (e.g. Tesco’s recent travails, BP and the Macondo oil spill), in other cases there may be a wide range of reasons influencing share performance (some having nothing to do with sustainability issues).
• Sustainability can be seen as part of ‘good business’ — the cause-effect issues tend to resolve by seeing CSR/sustainability as a bundle of aspects of what could be called ‘good management’ — and arguing that prudent risk analysis, strategic awareness and responsiveness to stakeholders (investors and others) simply makes good sense.
• Markets aren’t always very logical — hysteria and sub-second trading can easily swamp other trends (for more on the problems with current markets, see here).
• Statistics are never indicators of absolute truth and can be discussed endlessly — the examples listed below are not exhaustive and there will be other perspectives (and findings) out there!

Nevertheless, the following information presents a range of evidence as to why sustainability makes good financial sense.

Overall evidence

In my previous life at WWF UK, we produced a range of materials on the business case for sustainability, both by presenting data on the alignments between good practices and financial performance and by seeking to identify the mainstream investment tools and metrics that were capable of appreciating sustainability as a value-driver.

A simple expression of this work can be seen here.

At a larger and more comprehensive scale, a good ‘survey of surveys’ on the evidence for alignment between more sustainable companies and positive financial performance was published a few years ago by the Natural Capital Institute.

Reduced Volatility

Simple outperformance is not the only valuable metric for sustainability in financial terms. Share price volatility is also a critical aspect. While experts with bigger brains than mine might well argue it is simplistic to suggest that higher share price volatility is always a bad thing, it is generally thought that higher volatility is associated with greater risk, and that at a market level, it may also indicate a higher likelihood of a declining market.

There does seem to be a reasonable amount of evidence that good CSR and sustainability contributes to reducing share price volatility (which is almost as ‘valuable’ as pure outperformance). This research piece from the Network for Business Sustainability explores the relationships and the evidence.

In addition, this 2012 Deutsche Bank document presents an overview of sustainability and its impact upon long-term investments.

The 2013 Business in the Community (BITC) and Legal & General report, Conscious Capital: Bridging the gap between business and investor noted the contribution of sustainability to reduced volatility.

Additionally, this 2011 white paper from global asset management company RCM focused upon the performance of portfolios with integrated ESG (Environmental, Social and Governance) criteria.

Financial Outperformance

Beyond the evidence for reduced volatility, some research records the pure financial outperformance of the shares of more ‘responsible’ or ‘sustainable’ companies — that such companies (or the indexes they are featured in, such as FTSE4Good or DJSI) have better average share performance than those that are not prioritising sustainability.

This report from RobecoSAM focuses upon enhanced Alpha (a relative measure of performance on a risk-adjusted basis) from more strategic sustainability.

While here is Goldman Sachs saying the same thing (warning — it is long!), and also an academic thesis finding that SRI portfolios outperform the market.

This recent report from Arabesque Partners and the Smith School of Enterprise and the Environment presents a comprehensive overview of the relationships between different elements of sustainability with financial metrics and also focuses upon share price performance.

Finally, here is a very good overview on links, correlation, strengths and weaknesses.

Further exploration

There are many sources of useful information on this topic but one of the very best places to explore sustainability and financial performance is SRI-Connect. Run by sustainable investment pioneer Mike Tyrrell, SRI-Connect is free to join and not afraid to ask hard questions about the effectiveness of current sustainable investment while also presenting empirical evidence and expert insight into the progress that it has been made to date.

The UN PRI (Principles for Responsible Investment) initiative presents a wealth of evidence and thinking of sustainability and finance, including this publication, which presents approaches for communicating the business value of sustainability. In addition, the 2006 UN PRI document, titled Show Me The Money provides a comprehensive overview of the links between ESG issues and company value.

Conclusion

As noted above, this piece is neither comprehensive nor the last word on the subject of sustainability and financial performance.

As is often said, correlation is not causation and it is important not to state that there is always a ‘killer case’ for the financial outperformance by more sustainable companies.

Nevertheless, the available evidence is both persuasive and meaningful. Certainly there is more than enough evidence out there to persuade the potentially persuadable that sustainability is good for business right now. Until we have an economy that prioritises sustainability innately, we must use such evidence to take us another step towards a brighter future.