Does Sustainability Matter?

By Patricia Van Arnum - DCAT Editorial Director

May 28, 2014

How does sustainability fit into overall investment decisions and practices? Is it a way to achieve competitive advantage? A recent PwC analysis says "yes" as it examines the role of sustainability in financial decision-making.

What is the importance of sustainability in corporate and financial goals? How does sustainability factor into evaluating the performance of pharmaceutical companies and their suppliers? One measure of the importance of sustainability is to examine its role in the decision-making of investors. A recent analysis by PwC shows that sustainability issues are increasingly relevant to investors as they seek to integrate environmental and corporate responsibility factors in both current and future investment practices. Risk mitigation is the primary driver for considering sustainability followed by enhancing performance returns, and avoiding firms with unethical conduct.

"The purpose of this survey was to gain a deeper understanding of whether sustainability issues are affecting the decisions being made by investors," said Kayla Gillan, Leader of PwC's Investor Resource Institute, in a PwC press release. "Our research sought to gain insight from investors about how they are incorporating issues of climate change, resource scarcity, extreme weather events, and evolving corporate responsibility expectations into their investment decisions and strategies. We found significant evidence that an effect is occurring today—and that it is likely to increase in coming years," Gillan added.

In its report, PwC identifies the types and sizes of institutional investors that are integrating these issues into their investment strategies or practices, and more specifically, how they are doing so. A diverse range of institutional investors responded, representing more than $7.6 trillion in total assets under management (AUM), broken down as follows: asset managers (45%), pension funds (33%), mutual funds (7%), hedge funds (5%), and a variety of other organizations (10%).

The report showed that a large percentage (80%) of responding investors considered sustainability concepts in one or more investment contexts during the past year. The majority of these investors considered sustainability issues when they were voting proxies and deciding whether to engage directly with a portfolio company about a subject of concern. Very large investors (i.e., those with AUM of over $100 billion) are most likely to incorporate sustainability issues into their investment strategy, according to the PwC analysis.

The PwC report also showed that most investors anticipate considering sustainability in at least some aspect of the investment decision-making process. In the last 12 months, 82% considered climate change and/or resource scarcity in future investment decisions, and 79% of investors considered social responsibility and/or good citizenship, according to the PwC analysis. These issues will continue to factor into investors' future decision-making, with 87% expecting to consider climate change and/or resource scarcity over the next three years and 84% of investors expecting to do the same for social responsibility and/or good citizenship.

For those investors that considered sustainability issues as relevant are also more likely to have some form a direct communication on sustainability with their portfolio companies. Most investors who identified sustainability issues as relevant say it is "very likely" they will have some form of direct communications with their portfolio companies about this topic in the next 12 months. Of these investors, nearly 90% indicate they will "very likely" just request information directly from the company. More than two-thirds of investors in this group are "very likely" to seek a meeting with the companies' boards or management. Use of proxy—whether it is through shareholder proposals or "vote no" campaigns targeting company directors—is less likely, according to the PwC analysis.

Risk mitigation is the primary driver for considering sustainability issues. Nearly three-quarters (73%) of said the primary driver for considering sustainability issues is risk mitigation. Enhancing performance returns (52%) and avoiding firms with unethical conduct (55%) rank as other key drivers. Other factors weighed in as well. Thirty-six percent of respondents said that cost savings through reduction of environmental impact was a primary driver in considering sustainability issues and 52% said cost savings was somewhat of a driver. Almost one-third (30%) of respondents said that sustainability issues were a primary driver in attracting new capital, and 24% said it was somewhat a driver. In terms of overall value creation, 30% of respondents said sustainability issues were a primary driver, and 45% said they were somewhat a driver.

The analysis also pointed to areas in which improvement or other changes could be made to improve financial decision-making when it comes to sustainability. According to the PwC analysis, two-thirds of investors say that if common standards were used, they would be more likely to assess the materiality of environmental or social factors when making investment decisions. With Europe being the exception, the PwC report noted that investors in both the United States and other regions around the globe are dissatisfied with current sustainability reporting. The report showed that 68% of investor respondents in North America are dissatisfied with sustainability reporting and 61% of respondents in the United States are dissatisfied. In Asia Pacific, the numbers are higher, with 74% of investor respondents dissatisfied, and 87% of respondents in the Middle East and North Africa dissatisfied. The only exception to this trend is in Europe, with 62% of respondents saying that they were satisfied with sustainability reporting, and only 38% saying that they were not satisfied.

The PwC report also said the survey showed that investors are significantly dissatisfied with the current level of transparency and reporting of sustainability information with respect to US-listed securities. This disparity is most pronounced in the context of risk and comparability. Eighty-two of investors were dissatisfied with the financial quantification of risks and opportunities, with the comparability of information (79%) and relevance and implications of sustainability risks (74%) following close behind. The PwC survey also showed other areas in which investors wanted better information. Sixty-nine percent of investors were dissatisfied with how companies identified social and environmental impacts in its supply chain. Sixty-eight percent were dissatisfied with information on how key performance indicators related to each identified material issue as well as how a company's sustainability strategy is linked to a company's business strategy. Sixty-two percent of investors were dissatisfied with information on internal governance of sustainability issues, and 57% were dissatisfied with information provided on the internal processes used to identify material sustainability issues.

The PwC survey also asked investors in what areas should companies periodically assess materiality. Ninety-six percent of investors responding to the survey said that companies should have periodic assessments on the materiality of climate change/regulatory risk the leading area for which investors felt that periodic assessment of materiality was important. Other areas cited by investors were labor rights (95% of investors responded that periodic assessment of materiality was important), human health issues (92%), climate change/market risk (89%), resource scarcity/water quantity (89%), resource scarcity/water quality (87%), and climate change/physical risk (84%).