ESG investing and the value of deconstruction

ESG investing and the value of deconstruction

Framework CEO Kate Rebernak writes about the attitudes and connotations that adhere to words like “ESG”, “citizenship”, and “sustainability”. This article also appears in the Journal of Sustainable Banking & Finance’s May edition.

While in a meeting recently with members of the top management team of an iconic U.S. company (which we’ll call IconCorp), I mentioned, as I often do, that investors increasingly consider companies’ performance on environmental, social, and governance (ESG) issues in making investment decisions. The comment was based, in part, on the growth in the number of signatories to the UN Principles of Responsible Investment in recent years, the increasing amounts of money being managed by investment professionals who (say they’re) considering ESG factors in their investment process, and the growth in the number of shareholder resolutions over the past several years on issues such as board diversity, reporting on greenhouse gas emissions, and disclosure of lobbying spend and topics.

The response from one IconCorp executive was swift and dismissive. “We meet with our top investors regularly, and they never ask us about these issues.”

The conversation with IconCorp executives is illustrative of dozens, maybe hundreds, of similar conversations I’ve had in the twelve years I’ve been advising companies on integrating ESG considerations into business strategy and decision-making. Even given the increased focus on issues commonly included among the big umbrella of ESG—climate risk, human rights and supply-chain risk, board and management diversity, executive compensation, lobbying disclosures—we still hear from people in companies that investors never ask about ESG issues. The implication: ESG issues must not matter.

In this particular case, five of the ten firms having the largest holdings in IconCorp, and representing more than USD8.5 billion in shareholdings and more than USD10 trillion in combined AUM as of December 31, 2014, were signatories of the UN Principles for Responsible Investment. The largest of these (which we’ll call Big Investor) publicly reports that it 1) integrates ESG considerations into its investment process for 100 percent of its actively managed listed equities, and 2) engages with companies on ESG issues where there is a connection between the issue and financial risk.

So if IconCorp management hears no questions about ESG issues, it’s likely not that IconCorp has none worthy of discussion, but that Big Investor is asking about specific issues, business issues, material issues, without uttering a single E, S, or G.

Likewise, ESG analysts in some large financial institutions, hired specifically to help portfolio managers and analysts understand and integrate ESG factors into their analysis and investment strategy, have run into language issues within their own teams and often encountered reluctance to engage. Once they’ve stripped away the labels—the E, the S, and the G—and moved to a discussion of specific issues and areas of risk, they found they were examining many of the same issues: corruption in emerging markets, for example, or executive compensation structures, or the vesting of the CEO and board chair positions in one person.

What’s tripping us up is almost always the language.

Language has incredible power to influence thought, and vice versa. Research conducted by Lera Boroditsky, an assistant professor of psychology at Stanford University and a cognitive linguistics expert, shows how culture and language can dramatically impact perception and thought around concepts such as time, space, color, and even the characteristics of inanimate objects. It’s not an illogical leap to conclude that calling an effort corporate social responsibility, or sustainability, or citizenship, will dramatically impact the attention and resources dedicated to the effort or the perception of its value to a given stakeholder group, say, investors.

So in seeking to connect one idea to another, to persuade, and to understand, our language must be carefully wrought, our words chosen with pristine precision. And our society, in devaluing language, is leaving billions on the table. Some people, whether CEOs, CFOs, IROs, or PMs, hear “CSR”, “ESG”, or “sustainability”, and immediately tune out; those terms are not part of their language. But once they see the specific issues involved as risks or opportunities—once the idea is deconstructed and the fuzzy terms translated into the concrete language of business—the “why” of addressing those issues begins to become clear.

When we’re meeting with executives, having been approached to develop a “sustainability strategy” or a “corporate responsibility roadmap”, we begin the conversation with a level set to elicit understanding of why we’re there and what we’re talking about and to make sure we’re all pulling in the same direction. We ask: what do you mean when you refer to [sustainability, corporate responsibility, CSR]? What activities, risks, opportunities does the term call up? Why did you choose that term and how attached to it are you?

Then we deconstruct the idea. We lay out the issues of concern to stakeholders and draw the connection between those issues and business risk, or opportunity, as the case may be.

It’s when we move them away from their chosen term and start to talk about specific issues—often in terms of risk—that it begins to click. They get that managing energy consumption effectively not only lowers costs but can improve reputation. They begin to see the bottom-line impacts of maintaining a culture that either attracts talent or drives it away.

And if the time is right, they begin to understand that what they’ve been seeing as a nice-but-not-necessary program or a way to placate a few customers can actually be a business management approach that has the potential to generate long-term value for a broad range of stakeholders—including, ultimately, investors.

Now we’re talking.

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