Category Investments

Sustainability matters but it’s not all that matters

04 December 2023 Schroders
Kondi Nkosi

Kondi Nkosi

In the past, the negative effects of companies’ activities have been borne by society. But, from carbon pricing to sugar taxes, governments are increasingly reflecting them back on the companies responsible.

Companies and consumers are also paying more attention to the behaviour of the companies they choose to do business with.

SustainEx is the tool used by Schroders’ portfolio managers and analysts to assess these risks when making investment decisions. It helps to build up a fuller picture of the risks and opportunities facing individual companies by which quantifying the dollar-value of their negative and positive effects on society.

But, importantly, sustainability credentials are only one part of the puzzle, and should not be relied on in isolation. Many other factors influence the success or failure of a company, and an investment. When it comes to generating returns for our investors, valuations are key. It is the job of active investors such as ourselves to identify where the market is, and is not, pricing in these risks and opportunities correctly. This applies to sustainability as it does to many other relevant considerations.

Figure 1: The Spanish stock market leads the way, with SA in the middle and the UK at the bottom.

SustainEx is Schroders’ proprietary model of the dollar cost/value of a company or market’s effect on society, scaled to its sales for comparability. It gives an indication of the financial materiality of companies’ externalities and can be used to assess the risk to corporate profits if those externalities were reflected back on the companies that generate them. Data as at 31 July 2023. South Africa data generated October 11th. Source: Schroders

The Spanish stock market’s social credentials – and an illustration of how SustainEx works

A figure of 3.3% for the table-topping Spanish market means that, in aggregate, companies listed there have an unrecognised positive effect on society worth 3.3% of their sales.
Putting this in perspective, the consensus forecast is for Spanish corporate profit margins to be 11.3% over the next 12 months. But, if these positive externalities were to crystallise in financial terms, that would rise to 14.6%. In money terms, for every €100 of revenues, earnings would be €14.60, not €11.30, a 29% rise. Not something to ignore.

This does not mean that all companies will be impacted in this way or in this direction. This is our estimate of the potential aggregate impact when all Spanish companies are combined.

These figures, and others quoted in this article, should not be thought of as a forecast but instead as an indication as to the potential risks and opportunities facing different companies and markets. They are also not a reflection of any country itself, only the companies listed on its stock market.

So what’s behind the Spanish market’s strong showing? Its large utilities and telecoms companies provide valuable services for society including clean water, sewerage and sanitation.

SA ranks in the middle while the UK’s poor status masks many sustainable companies

Digging deeper into SA’s middling performance (in terms of total Sustainex score), there’s a stark difference between the stock market’s environmental and social rankings. It ranks highly in terms of social characteristics but poorly on environmental, driven by the high proportion of materials and mining stocks in the market. It is a top performer when it comes to its median ranking.

At the other end of the chart is the UK stock market, because of its exposure to tobacco and alcoholic drinks companies. These have direct health and indirect societal costs.

What the markets’ poor scores in aggregate don’t tell you is that our analysis suggests around half of the UK’s listed companies have a positive, unrecognised, effect on society. There would be upside financial benefits if this was recognised and crystalized on their profit and loss statement.

While it brings additional insights, our league table is too blunt to be used in isolation to drive investment decisions.

What should investors do?

A portfolio which excludes the markets of the worst offenders would obviously look far more beneficial to society than simply buying the broad global market. But excluding certain companies or sectors doesn’t stop harmful activities taking place. For every seller of shares there is a buyer. And maybe that buyer doesn’t care as much about engaging with companies to encourage a transition away from more harmful activities – an activity we at Schroders put a lot of effort into.

We are firm believers in the power and importance of active ownership and have a depth of experience that enables us to identify the most effective ways to engage with the companies we invest in. This can drive better outcomes for society and better returns for shareholders.

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