Sustainability metrics should grow along with bond yields
Could sustainability opportunities be captured without access to tangible metrics? For most of us, across all areas of business, the answer is likely a "no." In the absence of sound and comparable measures, any conversation regarding business opportunities and risks remains an opinion. Yet PwC’s latest Annual Corporate Directors Survey reports that almost one-third of the nearly 900 corporate board respondents have indicated they do not need nor have any expertise in the area of sustainability.
The financial community is made up of number and metrics-oriented people. We draw a deeper awareness to an issue when the magnitude of a phenomenon or a market trend is presented in measurable terms. At PineBridge, our credit analysis relies on understanding the sustainability implications of corporate actions on the financial health of an issuer by assessing its governance practices, the impact of its environmental footprint on the cost of its operations, the impact of labor relations in the instance of the unionized workforce and more.
Publicly listed U.S. companies of the caliber of Amazon, Dow Chemical, J.P. Morgan and UPS are represented in our universe of high-quality bond issuers along with hundreds of other brand names. They share a history of healthy cash-flow generation and a commitment to advance the economic value contributed to their respective end-markets. Could companies of such stature be at risk of running into "unsustainable" business practices?
Yes, they certainly could and, in some cases, they already might have.
In the U.S., the Sustainability Accounting Standards Board (SASB) has pioneered the work of codifying industry-level accounting standards for sustainability along with reference accounting metrics that make the financial and operational impact of ESG factors comparable and transparent. Nevertheless, the disconnect between governance practices and capital markets' increasing appetite for transparency is clear. To date, according to SASB’s 2017 State of Disclosure report, less than 30 percent of U.S. publicly traded companies have used quantitative metrics to address sustainability risks and opportunities in their SEC filings.
Our team has followed closely the work of SASB since its inception and adopted its assessment of materiality to account for those sustainability factors most likely to yield measurable financial and operational impacts. By applying the industry-level accounting metrics proposed by SASB to all corporations in our investible universe, we have been able to quantify the level of ESG risk concentration across sectors in terms of the number of companies affected by the SASB standards.
Our research found some impressive statistics from a materiality standpoint.
- Over 50 percent of companies in our investment grade universe have direct exposure to environmental factors such as water scarcity and wastewater management.
- About 47 percent are affected by their own energy management practices (or lack thereof).
- Nearly one-third are directly affected by issues surrounding employee health and safety and issues involving data strategy — both in terms of privacy as well as security concerns.
Not surprisingly, at the sector level, these sustainability dimensions exhibit a strong correlation with the structure of the supply chains and value networks that underpin the scale and growth potential of each sector.
The most striking data point to us is the issue of end-to-end lifecycle management of products and services. Product lifecycle management directly affects over 70 percent of U.S. investment-grade companies.
As a formal sustainability metric, it falls under the SASB’s Business Model and Innovation dimension and encompasses both a company’s ability to manage the shelf life of an existing product in a sustainable fashion as well as the launch of new products. Ultimately, the setup of an efficient lifecycle workflow is commensurate to how the design, sourcing, manufacturing, sales and after-market support functions are connected. It stems from an organization’s innovation efforts and its ability to grow it into a competitive advantage. As SASB measures point to, innovation is indeed a sustainability opportunity for companies.
Sustainability metrics are a powerful tool in redefining the key competitive advantage of each participant in the supply chain — and not only in terms of a company’s ability to retain and grow its customer base by expanding its sphere of influence in terms of consumer behavior. They foster productivity advances, lower cost of manufacturing and a more scalable distribution network within a sector.
In order to measure sustainability performance, we have introduced Key Risk Indicators (KRIs) that measure how an issuer is capturing (or not) the opportunities brought by pivoting a business model to be ESG compliant in the context of its own sector.
Not surprisingly, the most effective KRIs track material long-term trends including the level of capital expenditures devoted to fuel economy for transportation or automotive companies, or the size of the recycling programs for hardware and telecommunication companies compared to the cost of storage.
As sustainable business practices continue to contribute to cost leadership and productivity advances in a more transparent and measurable way, from an investment perspective investors and asset owners will be able to identify which sustainability trends are most likely to catalyze near-term positive externalities and deserve a premium on corporate valuations and favorable cost of capital assumptions.