Morgan Stanley
  • Investment Management
  • Dec 16, 2019

The ESG Advantage in Long-Term Investing

Investing in companies that lead in environmental, social and governance best practices is no longer niche—it’s one of the strongest ways to help ensure long-term, sustainable returns.

Approaching a new decade, our world faces a proliferation of challenges, from the impact of climate change and the growth of plastic waste, to ever more scarce safe drinking water and worsening malnutrition in many developing countries. Cynics might say that these problems have persisted for a long time. But something is different this time around.

The global zeitgeist has shifted, with more people embracing the tenet that what is good for the planet is good for all of us­, raising sustainability as the new imperative for good business, corporate stewardship and economic growth.

To that end, investors the over world are sounding a call to action. From our vantage at Morgan Stanley Investment Management, we hear clients continuously asking about how to integrate environmental, social and governance (ESG) factors in their portfolios. Today, sustainability factors have taken center stage for investors and fund managers. Consider the growth of professionally managed money that incorporates ESG criteria: Assets in the US reached $11.6 trillion last year, a 44% surge since 2016, according to a recent US SIF Foundation report.

Corporations are also responding. Earlier this year, the influential Business Roundtable, a consortium of CEOs from major companies, including Morgan Stanley, issued a new mission statement that redefines the purpose of the American corporation. It transcends a singular focus on shareholder value and necessitates a commitment to environmental and social impact objectives.

Political, regulatory and technological changes have made environmental and social concerns more important than ever before.

As many companies seek to embody ESG principles, investors are no longer assuming that sustainable investing sacrifices performance, or that it’s a niche strategy. Some realize that analyzing companies through an ESG lens can be, in and of itself, a differentiated driver of returns. Political, regulatory and technological changes have made environmental and social concerns more important than ever before, so it follows that allocating capital to high-quality companies that remain relevant with customers, improve employee engagement and stay on the right side of governments and regulators can provide solid financial performance and lower risk. Simply put, investing in companies with sound ESG practices means investing in better companies.

Three Compelling ESG Themes

Analyzing companies’ environmental, social and governance behaviors is essential in determining the viability of long-term returns. Some companies are more attuned to the issues that are relevant to consumers and their management teams embrace the increasing challenges of our complex world in efforts to build brand equity and offer robust long-term financial performance.

Long-term investors should consider three of the most compelling ESG examples in these higher-quality sectors:

1.      Consumer Staples: A number of companies in the industry have environmental and social policies that are both driving revenue and protecting the companies’ franchise for the long term. Businesses tackling the challenges of recycling are particularly interesting—some are developing environmentally responsible packaging, like removable label adhesives to improve bottle usability in recycling, while others are investing heavily in infrastructure to help increase the rate of recycling, or producing paper-padded vs. plastic bubble wrapping mailers. Some are also leading social responsibility efforts, like reformatting their beverage recipes to respond to regulation and an increasing global interest in reduced sugar consumption, or committing to sustainable sourcing of ingredients for commodity supply chains.

2.      Health Care: Some of our most pressing global issues are health-related, like the lack of proper nutrition and safe drinking water in certain parts of the world. Some companies are helping boost the nutritional value of rice, as half of the two billion people affected by micronutrient malnutrition reside in countries where rice is a staple food. Corporations that invest in rice-fortification technology, which adds essential vitamins and minerals, have succeeded in both reducing costs and improving nutrients, while others focused on water sanitation have developed innovative products that can be used safely, even when clean water is scarce.

3.      Software and IT Services: Data privacy and security are important issues. Companies that don’t primarily rely on monetizing sensitive consumer data are of greater long-term interest—even more so if they seek to balance their own interests with the impact that their big data analytics have on society. Corporations that also promote responsible values with initiatives that make a real difference benefit from having an engaged workforce, which is extremely valuable in the long term. Examples of these efforts include commitments to a diverse workplace and supply chain; inclusion initiatives, like the integration of people with autism into the workforce; the use of technology for environmental purposes, such as protecting endangered species or community education efforts that teach skills, such as coding or financial literacy to teachers and youth.

It’s crucial to enhance bottom-up fundamental analysis through active communication with company management to identify companies that lead in ESG issues.

Active Company Engagement

Direct engagement with companies is paramount when sourcing opportunities—and not all fund managers do it. Some outsource the work to others who may be far removed from making decisions that shape portfolios, while others rely on third-party ESG scoring data, which can raise reliability questions in assessing the likelihood of environmental or social risks.

A direct approach can offer a significant competitive advantage. While engaging with companies, investors can position their dialogue to address material and relevant ESG factors that affect the sustainability of returns. This can include asking about environmental issues, like carbon emissions, raw-material sourcing and packaging, or social concerns, such as supply-chain labor standards or product quality. Within governance, topics like capital allocation and incentives are always relevant.

It’s crucial to enhance bottom-up fundamental analysis through active communication with company management to identify companies that lead in ESG issues and, subsequently, consumer and workforce engagement. This approach offers the opportunity to invest with a conscience and be positioned for successful long-term financial performance.