Does Sustainability Matter?

An old adage says that we can't manage what we don't measure. This truism holds when it comes to companies' environmental, social, and governance performance. At a time when more and more investors are taking ESG criteria into account in their investment decisions, there has been a significant increase in the number of companies that disclose their ESG performance. This is good for the world, and it's good for investors.

ESG, GRI, SRI, oh my!
This week, the Governance & Accountability Institute released a report titled, "2012 Corporate ESG/Sustainability/Responsibility Reporting -- Does It Matter?" (link opens PDF file). I'll spare you the suspense: It turns out that yes, it does. The trends that emerge from the study's findings are significant, and they demonstrate that sustainable and responsible investing, or SRI, far from a passing fad, is a global force with increasing power behind it.

G&A Institute is well positioned to assess these issues. As the sole data partner for the U.S. for the Global Reporting Initiative, or GRI, G&A Institute gathers, analyzes, and databases corporate sustainability reporting to make it easier for investors to access and compare companies' ESG data. They have plenty to keep them busy. Consider that 53% of companies in the S&P 500 index reported sustainability information this year, up from a paltry 19% just one year prior. That is a staggering increase.

What's the business case?
So why are so many companies choosing to report on their ESG performance? G&A Institute says that investors "are becoming more aware that corporate financial statements alone are not necessarily effective in determining access to capital, cost of capital, share price and other valuations; thus, the rising interest in ESG factors."

Companies also see a less tangible benefit to sustainability reporting. G&A Institute's study found that reporting companies are more likely to be selected for inclusion in sustainability indexes, such as the Dow Jones Sustainability Index, and sustainability oriented "best of" lists, such as Newsweek's Green Rankings and Ethisphere's World's Most Ethical Companies list. Such factors contribute positively to brand recognition and perception.

G&A Institute's study also found that reporting companies tended to perform better in the markets over the long term, although I believe this particular study would be stronger if it analyzed more companies over a longer time horizon. Other such studies yield mixed results. Many researchers have sought to isolate the effect of sustainability initiatives on stock price. Investors know how difficult -- if not impossible -- it is to attribute stock price movements to a single variable.

In general, studies seem to show a small but positive correlation between companies' management of ESG issues and long-term market returns. The signal tends to be weak, but it becomes stronger when studies look at more specific parameters. For instance, one study found a strong relationship between oil and gas companies' business performance and their inclusion on the Pacific Sustainability Index.

One thing is clear: Investors' appetite for SRI is growing massively. The US SIF Foundation released its "2012 Report on Sustainable and Responsible Investing Trends in the United States" last month, in which it reported a 22% increase in SRI assets under management at the end of 2011 compared to only two years prior. SRI now accounts for 11.23% of global investments, and it's growing much more quickly than the rest of the market.

The cream of the sustainability crop

The following companies are all included in the Dow Jones Sustainability Index, and all report robustly on their ESG initiatives. The CAPS score represents the extent to which The Motley Fool's online community of investors believes the stock will outperform the market, from a low of one star to a high of five.

All of these companies describe their sustainability initiatives as a business imperative.

More and more companies are coming to the same conclusion. For the first time in the S&P 500's history, non-ESG-reporting companies have become the minority. With my own money, I'm going to bet on the proposition that companies that integrate sustainability into their overall management frameworks will be better long-term investments than companies that don't. The data show that I'm not alone.