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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 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?

Our surveys show that more and more of our clients want to align their investments with their values. I believe money managers have a moral imperative to help drive the transition to a sustainable economy. We can do this 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. I disagree. In fact, I believe that it is only by investing in truly sustainable businesses that we can achieve consistent investment returns over the long run.

In my view, 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?

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

stakeholders-394422.jpg

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This way of thinking is becoming increasingly outdated.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.

A familiar case in the UK is retailer Sports Direct which became infamous in 2016 after reports emerged of ‘inhumane’ working conditions in its warehouses. Consumers boycotted the stores, resulting in a sharp deterioration in sales and profits, and the share price reached a low of 70% below its 2015 peak (Source: Bloomberg. Stock peaked at 809p on 10 August 2015 and troughed at 252p on 26 July 2016.)

In the US, one of the biggest cautionary tales comes from bank Wells Fargo, which hit the headlines in 2016-17 over account fraud. The scandal illustrated a number of failings in the bank’s treatment of clients, employees and regulators. Clients were harmed by having accounts opened without their consent, incurring fees and impacting their credit ratings. The scandal resulted from the pressurised working environment and extremely aggressive sales targets for employees, which led them to take desperate measures to meet quotas. Meanwhile, the corporate culture and the bank’s response to initial allegations demonstrated a flagrant disregard for regulators.

The impact for shareholders has been painful: billions of dollars in fines and litigation, widespread branch closures, and a significant loss of business. The company’s shares have been broadly flat since the scandal broke, underperforming broader US banks by more than 60% (Source: Bloomberg, total return vs S&P 500 Banks Index since September 2016). 

We can also point to companies that have borne the cost of environmental disasters – BP’s Deepwater Horizon explosion and oil spill for example, or the catastrophic collapse of a Vale tailing dam in Brazil last year, killing 270 people. And those that have incurred reputational and economic damage from customer boycotts over unpaid tax (e.g. Starbucks in the UK), showing 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, UK engineering firm Spirax Sarco spends more than all its competitors combined on training, resulting in a trebling of sales productivity for the average recruit during their first five years at the company (source: company meetings and Schroders analysis).

At semiconductor manufacturer Texas Instruments, average employee tenure is an impressive 12 years and all staff are paid a bonus based on the company’s profit each year, encouraging a collaborative and innovative culture (source: Texas Instruments Corporate Citizenship Brief 2019).

We can also think of examples where charitable projects and local investments have drawn support from the local community and authorities; and where a reputation for environmental stewardship is strengthening a brand and drawing in new customers.

Sustainable businesses can thrive in the long term

These examples illustrate that there is a symbiotic relationship between a company and its stakeholders: I like to think of it as a kind of ‘corporate karma’.

As well as avoiding harm, there is growing recognition that taking care of stakeholders has positive business benefits. The Business Roundtable, an association of CEOs from leading US companies, recently changed its purpose to include an explicit commitment to all stakeholders.

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 analysis also struggles 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. I find this very exciting, as it offers an opportunity for investors to exploit mispricing in the market, and reap the benefit when those sustainable companies keep beating market expectations.  

As investors, we can do our part to encourage companies to be more sustainable – improving outcomes for both our clients and wider society. We engage with companies proactively via conversations with management when we 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.

And as company owners, we have a vote that we can use at annual general meetings to signal our agreement or disagreement with management’s policies. The Schroders Sustainable Investment Team voted on 740 meetings in the fourth quarter of 2019, with 12% of these votes cast against management.