- Publicly listed ESG leaders earn an average annual return of 12.9%, compared to that of an 8.6% annual return for laggard companies.
- Private sector companies that rank in the top 25% of their industry for executive team gender diversity have annual revenue growth around two percentage points above that of companies in the bottom quartile.
- Companies that focus on ethical supply chain practices post profit margins three percentage points higher than rivals.
It is baffling that the debate about the link between sustainability and profitability continues. In the US, in particular, it has become entrenched as an article of faith. The need to “protect Americans’ savings” from “leftist causes” was the call to arms from one right-wing media group last week.
But the anti-sustainability position has moved far beyond the lunatic fringe of the Republican party.
In June, Larry Fink, chief executive of BlackRock ($10trn AUM), speaking at the Aspen Ideas Festival in Colorado, said that he no longer uses the term ESG because it had become “weaponised” and “misused by the far left and the far right”.
Last year, Capital Monitor looked at the connection between the two and found that businesses which express a commitment to ESG have seen profits jump 9.1% over the past three years.
If anything, those figures have risen. McKinsey, a consultancy, has recently examined how companies that achieve better growth and profitability than their peers while improving sustainability and ESG outgrow their peers and exceed them in shareholder returns.
“Revenue growth is good. Profitable growth is better. Profitable growth that advances ESG priorities is best,” it said.
Better equity returns
The body of research was added to last week by risk and financial advisory solutions provider Kroll which looked at data from more than 13,000 listed companies around the globe and from a variety of industries.
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It found overwhelmingly that companies with better ESG ratings outperformed their peers with lower ratings.
“Quantitative analysis of the relationship between ESG ratings and equity returns is a critical component for evaluating ESG-based investment decisions,” says Carla Nunes, global leader of the valuation digital services group at Kroll.
The group analysed the relationship between a company’s total stock returns and its MSCI ESG rating between January 2013 and December 2021, splitting them into “leaders”, “average” and “laggards”.
Europe’s figures were particularly strong, with nearly a third of companies being rated as leaders. This compares to just 10% in North American and 6% in Asian companies. These two regions, it should be noted, also had a higher proportion of laggards at 17% in North America and 38% in Asia.
Significantly, the study showed that European ESG leaders earned an average annual return of 10% compared to an average of 7% for laggard companies. Globally, the research found that ESG leaders earn a hefty average annual return of 12.9%, compared to that of an average 8.6% annual return earned by laggard companies.
As the report makes clear, this represents a not-too-shabby 50% premium in terms of relative performance by top-rated ESG companies.
Nunes believes that this trend is likely to continue for the foreseeable future, thanks primarily to legislative support in Europe. She says that the performance of the region is “underpinned” both by the region’s commitment to ESG but also to the EU Sustainable Finance Disclosure Regulation (SFDR) and the European Sustainability Reporting Standards (ESRS).
Marked in the private sector
The connection between financial and ESG performance is more familiar in the public markets, but it is as marked in the private sector.
Looking at the 100,000 companies tracked by EcoVadis – more than 95% of which are private –consultancy group Bain found that there was a strong correlation between ESG activities and stronger financial profitability and growth for private companies.
“This new data shows that positive ESG outcomes are a trait of successful companies,” says Axel Seemann, advisory partner at Bain and one of the authors of the report.
While many factors influence a company’s financial results as the report itself admits, it was able to draw out four correlations between ESG activities and business results
First, companies with more women on the executive team have better financial results. Those that rank in the top 25% of their industry for executive team gender diversity have annual revenue growth around two percentage points above that of companies in the bottom quartile. And their EBITDA profit margins are also three percentage points higher than that same group.
“Other studies have attributed this to the fact that having a diverse leadership team provides a broader view of opportunities and risks,” the report says.
Second, ESG leaders have higher employee satisfaction; companies with the most satisfied employees grow faster and are more profitable. They have three-year revenue growth up to five percentage points above those with less-satisfied employees and margins as much as six percentage points higher than laggards.
Third, companies that focus on ethics, environmental and labour practices within their supply chains are more profitable. They tend to have margins that are three percentage points above those that don’t focus on their supply chains.
And fourth, renewable energy usage correlates with higher EBITDA margins in carbon-intensive industries.
“In the EU, where there is a carbon tax, lowering emissions directly benefits the bottom line; around the world, greater use of renewables also helps hedge against fluctuating fossil fuel prices, and sometimes it’s just cheaper,” the report says.
The financial benefits of ESG are increasing year-by-year. As Bain’s Seemann says: “We only expect this correlation to strengthen as ESG data becomes richer and more nuanced”. To deny it for any reason, let alone ideological ones, is financial self-harm.
[Read more: Link between ESG and profitability exists: New research]
