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Sustainable Investing – Time For A Holistic View

Karl Herzog and Thomas Funk from the Swiss equities team explain how they screen companies based on a comprehensive list of sustainability criteria. Their goal is as simple as it is ambitious, aiming to identify the long-term winners in an increasingly complex and competitive environment.

Friday, September 29, 2017

With hurricane Irma and tropical storm Harvey we saw two extreme weather events causing devastation to millions of people within just two weeks. Many scientists argue that climate change could increasingly add to the frequency and magnitude of such natural catastrophes, which not only cost many lives but also create economic emergencies in the affected regions. In our globalised society this serves as a reminder that our interactions with the ecosystem may have serious consequences for all of us.

Many experts see international corporations as the main responsible parties causing harm to the planet. Corporate value chains that convert raw materials into goods which we consume on a daily basis are often highly complex and globally interlinked, and this naturally gives rise to a whole host of sensitive interactions between people and the environment that are hardly supportive to sustainable development. Therefore, as active long-term investors, we recognise that supply chains in the future are to be largely redesigned and that many companies will have to rethink their business models.

Beyond ESG

In the investment community most approaches towards sustainability are derived from a backward-looking point of view. We see these typically structured under the banner of environment, social and governance issues, commonly known by the acronym ESG. We believe that it is time for a more holistic view which allows for coherent, forward-looking and situation-specific assessments and solutions.

Twenty years of investment experience confirmed our view that resilience and perpetuation – the ability of corporations to uphold value creation on an ongoing basis – are of paramount importance to businesses. A company, in addition to financial profit, has to also incorporate values such as the intact functioning of the ecosystem and the dignity of individuals, as well as the diversity and stability of the entire social system into its value creation. To identify such businesses, we need an appropriate lens through which we can detect and assess the corresponding qualities of corporations. We developed such a lens on the basis of systems thinking and analogies to the overarching design principles of living nature. As a result, we have identified six key criteria on which we build our integrated approach to sustainable investing.

Key criteria for corporate sustainability
  1. Renewability: flexibility, continuous renewal, evolution, adaption, capacity of innovation and creativity
  2. Cycle: closed loops of material and energy flows, feedback-loop communication enabling self-organisation and self-regulation
  3. Network: networks of communication and coordination, complementary structures, industrial symbioses, integrated design based on functional synergies
  4. Use of location: consideration and use of naturally given location factors and of the corresponding geographic diversity of resources, ecosystems and society
  5. Multi-functionality: consideration and use of the functional diversity of living systems, multi-functional design of materials, systems, products and jobs
  6. Legal compliance: conformity with written and unwritten norms and values of the relevant societies
Evolving awareness

During the years of analysing companies through our sustainability lens, we have witnessed a significant change in awareness of the topic. In the 1990s, the main focus of companies usually was on technical environmental protection. In many industries the sustainability topic was handled by departments which were responsible for toxic substances. Back then, factory tours quite often led us to the basement, where dangerous goods were stored. In the past decades there has been a slow but gradual shift of recognition in this regard. Responsibilities have been defined in much more detail at a corporate level. The boards of directors and senior management are now conscious that ultimately they can be personally held accountable for wrongdoings of their companies.

In capital markets there is also an increasing pressure for investors to take responsibility for the companies in which they hold shares – via corporate governance mechanisms – and to hold their investees accountable for more sustainability. However, in our view this concept is challenging and has not been very successful to date. Companies allege that demands from shareholders are often not sufficiently tailored to the specific situations of their businesses. We understand their concern. In our analysis we actually favour individuality. We are constantly looking for independent, innovative and competitive businesses.

The power of the consumer

Recently, we have seen another encouraging development: companies start to recognise that it is increasingly their end customers that are demanding sustainability. This, for some firms, opens up new opportunities for differentiation, while for others it is simply a matter of staying in business. End consumers are providing increasingly powerful momentum, which is being felt throughout the entire value chain. For example, certain manufacturers of luxury goods are no longer satisfied with their suppliers if they only provide information on abstract sustainability standards; they want to see concrete improvements that can be made visible also to end customers. Sustainability labels and certification papers are no longer regarded as sufficient.

The change in consumer expectations will be a primary driver for the performance of businesses in the coming years. Companies are well advised to listen to their customers, because they send signals from a new generation with new needs and dreams. The firms which manage to proceed most rapidly to a more sustainable business culture will have a competitive advantage and they will be able to create a particularly large added value for their stakeholders.

The Swiss stock market: a true global player

Despite its modest size, Switzerland has one of the world’s most competitive stock markets, and thanks to its political stability and business-friendly environment, it also serves as a hub and headquarters for many multinational enterprises. Not only giants such as Nestlé, Roche and Swiss Re but also many less known Swiss corporations are global leaders in their respective industries.

We have used and refined our holistic sustainability approach to assess Swiss-listed companies, and our experience over the past two decades has been very positive. Not only can we assess how a firm fits into its ecological and social context, we can also evaluate whether it has the organisational preconditions necessary to evolve as a viable entity capable of creating value in a competitive environment. Our analysis over the years shows that the presence of our sustainability traits is closely linked to a firm’s economic success. It is fair to say that considerable progress has been made in the field of corporate sustainability in recent years, and many Swiss companies are at the forefront of this development, both in terms of the established business standards as well as their global responsibility.

Important legal information
The information in this document is given for information purposes only and does not qualify as investment advice. Opinions and assessments contained in this document may change and reflect the point of view of GAM in the current economic environment. No liability shall be accepted for the accuracy and completeness of the information. Past performance is no indicator for the current or future development.