Perspective

Managers' views

Why “corporate karma” is crucial for your investment returns


Katherine Davidson

Katherine Davidson

Portfolio Manager, Global & International Equities

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Sustainability used to be a niche preoccupation, but it is now discussed everywhere. From “flight shame” to the gender pay gap, issues related to sustainability have become part of our everyday conversation. Many of us are trying to do more at a personal level to live more sustainable lives, such as cutting down on single use plastic. But what about our investments?

Schroders’ Global Investor Study 2019 shows that more and more investors want to align their investments with their values. Money managers shall have a moral imperative to help drive the transition to a sustainable economy. This can be done by directing more capital to sustainably-run companies and by engaging with the companies we own.

Many investors think there has to be a trade-off between sustainable investing and generating market-beating returns. However, it is only by investing in truly sustainable businesses that consistent investment returns can be achieved over the long run.

The key to sustainable investing is to look at how a company deals with its stakeholders. Companies that are run with consideration for all their stakeholders can deliver better long-term returns and be less likely to experience expensive – even existential - controversies.

What do we mean by stakeholders?

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Stakeholders are – as the name implies – any party that has an interest in something, in this case a business. The chart above shows the range of stakeholders in any company; The relative importance of stakeholders will vary depending on the nature of the business. Shareholders are a stakeholder, but just one among many.

The concept of “shareholder primacy” is one that really took hold in the 1970s. This is the theory that shareholder interests should be the top priority for companies, over and above their other stakeholders. This led to a prevailing assumption that companies should be run to maximise profits for shareholders, regardless of the wider impact.

This way of thinking is becoming increasingly outdated. Maximising shareholder returns while damaging the environment, for example, is increasingly unacceptable to employees, customers and wider public opinion. This reputational damage could deter customers – resulting in a loss of market share - and make it hard to recruit and retain workers. It could also lead to regulators imposing stricter standards or levying fines.

This is by no means an exhaustive list of potential consequences. Clearly all of these outcomes would impact a company’s profits – ultimately harming shareholders as well.

Stakeholder relations in the real world

Moving beyond the hypothetical, there have been numerous examples in recent years of companies where mistreatment of stakeholders has had wider ramifications. The impact for shareholders has been painful: billions of dollars in fines and litigation, widespread branch closures, and a significant loss of business.

We can point to companies that have borne the cost of environmental disasters, incurring reputational and economic damage from customer boycotts over unpaid tax. This shows that customers are prepared to hold companies accountable for their responsibilities to wider society.

Positive examples rarely hit the headlines, so are harder to illustrate. But there are many examples of companies where, for instance, exemplary treatment of employees has resulted in long-tenured, deeply-committed workers, boosting productivity and reducing costs associated with staff turnover.

For example, charitable projects and local investments have drawn support from the local community and authorities. Reputation for environmental stewardship can also strengthen a brand and draw in new customers.

Sustainable businesses can thrive in the long term

The symbiotic relationship between a company and its stakeholders can be seen as a kind of ‘corporate karma’.

As well as avoiding harm, there is growing recognition that taking care of stakeholders has positive business benefits. However, financial markets still tend to be very focused on the short term. Analysis of many companies tends to focus on their prospects for at most the next two or three years, if not just the next couple of quarters. Conventional financial analyses also struggle to capture non-financial factors, such as corporate culture and stakeholder relations.

This means that the wider market often underestimates and undervalues the resilience of growth and returns that sustainable companies can deliver, which can be an exciting opportunity for investors to exploit mispricing in the market, and reap the benefit when those sustainable companies keep beating market expectations.  

Investors can encourage companies to be more sustainable – improving outcomes for both the stakeholders they represent and the wider society. They can engage with companies proactively via conversations with management when they have concerns over the treatment of stakeholders. This includes tracking outcome data (both reported and unconventional) and having follow-up meetings to see if our concerns are being acted upon. As company owners, they will also have a vote that they can use at annual general meetings to signal their agreement or disagreement with the management’s policies.

 

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