Most Corporations Fail to Address Long-Term Profitability Risks
"Look at the high levels of risk that investors were subjected to in 2008," Gordon told SocialFunds.com, referring to the current global fiscal crisis. "It's clear now that if corporations had done a better job of managing risks and providing adequate disclosure, then investors could have used that information, not only in their investment decisions but in engaging as owners with the companies in which they invest."
As an indication of growing collaboration among investors, Gordon referred to a letter sent to 9,000 companies by more than 50 PRI signatories that hold $4.4 trillion in assets, requesting clarification of their positions on mitigating risks and providing disclosure. He believes that the letter stands as evidence that the tide may be turning in favor of active engagement by investors in the companies they own.
"Get involved with PRI!" Gordon implored investors, referring to the U.N.'s Principles for Responsible Investment (PRI), a framework for investor management of environmental, social and corporate governance (ESG) issues that can affect the performance of investment portfolios.
The PRI, whose signatories manage assets exceeding $15 trillion, advocates for the inclusion of environmental, social, and governance (ESG) risks into investment decisions; activist engagement with companies to ensure that ESG issues become part of corporate policy; and collaboration among investors to enhance effectiveness in achieving its goals.
The EIRIS report, which addresses all investors but particularly those who have signed onto the PRI, "explores the key environmental, social and governance (ESG) risks and opportunities identified by the U.N. Global Compact of human rights, labor standards in the supply chain, environment and anti-corruption." It found that "the majority of companies are exposed to significant risks on these issues." Furthermore, "Eighty percent of companies in the FTSE All World Developed Index face significant unmanaged ESG risks."
The report categorizes companies according to risk in the areas of human rights, labor standards in the supply chain, environment, climate change, and bribery and corruption. With the exception of management of environmental risks, in which over 50 percent of high-impact companies demonstrated a good management response, high-risk companies have largely failed to mitigate risks in any area.
Less than 20 percent of high-risk companies have mitigated the risk of labor rights abuses in their supply chains. Without the external pressure by shareholders on apparel companies, whose advanced response merited a best practice designation by EIRIS, the percentage of companies demonstrating a good response would likely have been considerably lower.
In the other areas surveyed in the report, no more than 10 percent of high-risk companies demonstrated a good response to risk mitigation.
On the subject of disclosure, the report found that "disclosure levels are generally not good enough for investors to be clear about the risks they face, or what companies are doing to manage their risks."
Only in the areas of environment and climate change did disclosure levels among high-risk companies surpass 2.5 percent. The report finds a correlation between the higher level of climate change disclosure among high impact companies and membership in such reporting initiatives as the Carbon Disclosure Project (CDP).
The EIRIS report provides four recommendations to assist investors in their consideration of ESG issues: integrate ESG risk into investment strategy; actively engage with companies to improve their performances; insist upon better corporate disclosure, in part by promoting reporting initiatives as the Global Reporting Initiative (GRI) and the Carbon Disclosure Project; and support the PRI.
SocialFunds.com asked James Gifford, Executive Director of the PRI, how institutional investors would benefit from becoming PRI signatories.
"ESG coverage has a long way to go," said Gifford. "But the key point is shareholder engagement in order to encourage companies to disclose systematically. Over the next few years we expect ESG coverage to improve dramatically, and we plan to encourage a significant increase in signatories from currently underrepresented emerging markets."
In an effort to systematize ESG information and encourage collaboration among PRI signatories and other institutional investors, EIRIS appended information about its PRI toolkit to the report. The three products developed by EIRIS seek to provide systematic information to investors based on the first three of the six Principles for Responsible Investment.
Gordon of EIRIS said of the toolkit, "The aggregation of so much information will help investors integrate the principles of PRI into their investment decisions. We believe the toolkit contains the first products directly linked to PRI."
Gordon is not alone in believing that the current fiscal crisis presents opportunity for responsible investment. The rapid decline of stock prices should lead asset managers and individual investors to question the value of the strategies that led directly to the crisis. The quest for short-term gains led many investors to ignore risks both financial and related ESG issues.
In contrast to a focus on short-term gains, sustainable investment strategies emphasize long-term returns for shareholders.
This article originally appeared at SocialFunds.com.