Photo: Usukhbayar Gankhuyag. Source: Unsplash
Having a sustainable lifestyle is important. We need to eat well, get enough rest, get regular exercise, and be engaged socially in meaningful relationships. We also need to live within our means, spending less than we earn, and setting cash aside for a rainy day, for times when we may be sick or out of work. If our lives get out of balance, something eventually has to give way.
“Sustainability” is an important investment concept, too. When a business is managed well, it should be able to generate long-term financial returns for its investors. By contrast, companies that lurch from crisis to crisis eventually come to a bad end.
As an example, look at Enron – the “crooked E.” The were brought down by a massive accounting fraud. But just as significantly, the company was obsessed each quarter with “making their numbers”: finding ways to recognize a deal early or defer the earnings until later so they could hit Wall Street analysts’ expectations. Each quarter-end saw a frantic dash of financial adjustments and special transactions designed to meet or exceed expectations. Eventually, a host of talented employees burned out and quit. If Enron hadn’t been brought down by its financial shenanigans, it would have collapsed internally due to a lack of good people.
Sustainable businesses treat their employees with respect, don’t deplete or pollute the environment, and are good corporate neigbors. These environmental, social, and governance (ESG) factors aren’t just catnip for “do-gooders.” They’re critical building blocks to long term success.
Some scholars recently performed a meta-study of Environment, Social, and Governance goals, examining about 2200 research papers comparing ESG factors with corporate financial performance (CFP). They saw that the majority of studies showed a modest, positive relationship. Another investment analysis indicated that ESG factors add about 0.25% annually of additional investment return to a portfolio. This makes sense. You can’t eat your seed corn and expect to do well over the long term. Good people want to work for good companies where they believe that what they are doing has a good impact on the world.
Source: Friede, Bushe, & Bassen
Of course, like all things, sustainable investing goes in and out of style. People are herd animals, we feel that there’s safety in numbers. So ESG portfolio performance tends to wax and wane with the winds of fashion. One investment group put together competing portfolios of top and botton-quartile ESG scores and compared their returns, essentially creating a long-short portfolio. They found that the top firms did beat the bottom group, but not all the time. There are situations and seasons when being bad is more profitable than being good. But not in the long run.
Source: CFA Institute, Vontobel Asset Management
Focusing on what matters most – our relationships, our mental and physical health, our lifestyle – is critical if we want to stay calm when the world is shouting at us, when Mr. Market is playing his manic-depressive mind games. If we have a strong, sustainable personal foundation, we can keep our heads when everyone around us is losing theirs. The same holds true for the companies we invest in. Economic and market volatility can create opportunities, but only if we’re prepared.
Douglas R. Tengdin, CFA
Charter Trust Company
“The Best Trust Company in New England”