A successful ESG strategy matters more than ever

These steps can improve your company’s standing with socially responsible investors

The coronavirus pandemic has brought the global economy to a standstill but seems unlikely to slow the rise of socially responsible investing.

Investors in the U.S. poured more than $10 billion into sustainable funds during the first three months of the year, surpassing the record set in the fourth quarter of 2019.

Along with the broader market, index funds that invest in companies that score well in ratings of environmental, social and governance (ESG) factors fell in value in the first quarter but less than funds that are not benchmarked to ESG. Credit the outperformance in part to the tendency of such companies to be run better; to avoid things that make them “brittle,” as Eric Ries, LTSE’s founder and CEO put it recently.

If the new normal adds to the rush of capital into sustainable investing, which already accounts for roughly one of every four professionally managed investment dollars, it also means that ESG scrutiny is here to stay.

Public companies receive dozens of questionnaires a year from ESG ratings firms that each ask hundreds of questions that may tie loosely if at all to the risks particular companies actually face or the impact they may have. The ratings firms that send them will rate your company regardless whether you answer the questions. And investors will rely on those ratings to construct portfolios.

So what’s a company that aims to build a sustainable business and qualify for capital benchmarked accordingly to do? The answer is not to hire experts in filling out questionnaires. A great ESG strategy has nothing to do with maximizing disclosure for the benefit of ratings firms and everything to do with driving performance on the things that matter to long-term shareholders and other stakeholders. Here are three suggestions for where to start.

1. Manage risks that are material for your industry

Managing material ESG risks is the first step toward a coherent strategy. Material issues are the things that may affect the operating performance or financial condition of your company — things that an investor would think are important. Material ESG risks are often industry-specific. For example, for technology companies:

For a primer on what could be material for your industry, the Sustainability Accounting Standards Board (SASB) has developed evidence-based standards with investors in 77 industries across 11 sectors. Use this as a guide to think about what ESG issues your company might be exposed to, how well you are managing them, and how to communicate ESG risk to investors.

2. Future-proof by aligning with stakeholders

No ESG framework, no matter how thorough, will help you to identify every emerging risk or hot-button issue in a rapidly changing landscape. Nor will it help you communicate impact, which is equally important.

The public backlash over plastics hit companies quickly as advocacy spread via social media. Opioid addiction took down pharma companies in rapid succession, affecting the entire industry. Three years ago, the #MeToo movement had yet to be unleashed, and now investors ask founders to sign “MeToo” clauses. The coronavirus pandemic reminds us that the unexpected happens.

The future of ESG belongs not to risk, but to resilience. Resilience comes from aligning with stakeholders. Your company’s employees, customers, suppliers, and communities are its social capital. They make the difference between creating shared value or derailing your long-term strategy.

Doing right by employees motivates them and benefits your business through higher productivity, retention, and innovation. Building products or services that delight customers boosts revenue. Creating well-paying jobs and supporting the social fabric of your community not only strengthens society but also spurs pride among workers and customers. Treating suppliers as partners enables them to deliver quality products and competitive prices.

Identify those stakeholders who are critical to your company’s long-term success and treat them as first-class members of your decision-making process. Creating two-way channels of communication with stakeholders can help you to flag emerging issues before they become material.

3. Tell your story in ways that resonate with investors

This is the capital market, so bring it back to money. Demonstrate how your company works to reduce exposure to risks and improve society in ways that fuel growth and deliver superior returns over the long term.

Start with authenticity and commit to governance that supports a long-term orientation. You will create the runway to invest in ESG initiatives, and the capacity to adapt to what’s emerging, which confers an advantage on any company that aims to build a sustainable business. That will attract not just the quarter of investment capital that cares about ESG, but the other three-quarters of the market too.

For more information on how LTSE helps modern companies with big transformative visions build for the long-term, please reach out to me or visit us at ltse.com.