Sustainability Insight
ESG and the Sustainability of Competitive Advantage
 
 

Sustainability Insight

ESG and the Sustainability of Competitive Advantage

 

A holistic approach to sustainability with respect to disruptive change, financial strength, environmental and social externalities and governance (ESG) helps us identify investment opportunities characterized by competitive advantages that can potentially be monetized through growth.

ESG is a Component of Quality

We believe that ESG factors are integral to assessing the quality of a company. When we formulate our investment thesis on the quality of a company, we ask three key questions1 to determine the sustainability of competitive advantage and how it can be monetized through growth:

  • Is the company a disruptor or is it insulated from disruptive change?
  • Does the company demonstrate financial strength with high returns on invested capital, high margins, strong cash conversion, low capital intensity and low leverage?
  • Are there environmental or social externalities not borne by the company, or governance and accounting risks that may alter the investment thesis?

 

ESG FACTORS MAY MATERIALLY IMPACT INVESTMENT RISK AND REWARD. Companies are increasingly confronted with environmental issues, social factors and relationships with regulators and the communities in which they operate. In this context, managing ESG factors is simply part of sustaining competitive advantage in today’s economy.

ESG EXTERNALITIES MAY NOT BE NOT FULLY PRICED INTO THE VALUE OF COMPANIES. When companies externalize the price of environmental and social issues upon the communities in which they operate, they are by definition over-monetized—earning excess profits because the costs of externalities are not borne by the company. Investors risk paying the price when such excess is corrected and environmental and social costs are internalized to the company income statement.


ESG RISK EVENTS HAVE MATERIALLY DETRACTED FROM PERFORMANCE. In recent years, shareholders have suffered substantial losses following ESG risk events—while there is no silver bullet to avoid investing in such catastrophes, we believe that incorporating ESG analysis can mitigate risk consistent with our duty as fiduciaries. 

 
Our Quality Assessment of Companies
 
 
 
 

Long-Term Ownership Mindset

We seek to own big ideas that win over time. Over extended time horizons, we believe that ESG risks are more likely to materialize and externalities are more likely to be priced into the value of securities. Therefore, we continue to innovate and evolve our process and believe that integrating ESG within our investment analysis improves the investment risk and reward profile of client portfolios. 

 
Managing Director
 
 
Executive Director
 
 

1 The information presented represents how the investment team generally applies their investment processes under normal market conditions.

The views and opinions are those of the author as of the date of publication and are subject to change at any time due to market or economic conditions and may not necessarily come to pass. Furthermore, the views will not be updated or otherwise revised to reflect information that subsequently becomes available or circumstances existing, or changes occurring, after the date of publication. The views expressed do not reflect the opinions of all portfolio managers at Morgan Stanley Investment Management (MSIM) or the views of the firm as a whole, and may not be reflected in all the strategies and products that the Firm offers.

This material is a general communication, which is not impartial and all information provided has been prepared solely for informational and educational purposes and does not constitute an offer or a recommendation to buy or sell any particular security or to adopt any specific investment strategy. The information herein has not been based on a consideration of any individual investor circumstances and is not investment advice, nor should it be construed in any way as tax, accounting, legal or regulatory advice. To that end, investors should seek independent legal and financial advice, including advice as to tax consequences, before making any investment decision.

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