When it comes to sustainability are we using the same word to describe activities that are inherently at odds with each other, or not?
Sustainability has become a popular word of late, however, the meaning of sustainability can vary dramatically depending on the audience or context of the word being used. As investors, we assign a particular meaning around the sustainability of cash flows and the business model to estimate whether a company is likely to endure and produce attractive returns for clients over time. Whereas an environmental charity, for example, might understand sustainability in the context of the UN Sustainable Development Goals (SDGs), which strive for a balanced world, where species and resources are in equilibrium. In this latter context the operations of a profit pursuing company which is inevitably motivated and rewarded for growth may well be seen as a threat, however ‘sustainable’ its cash flows in a pure economic sense.
We have questioned whether an investor’s definition of sustainability is potentially at odds with that of other sectors of society or of the SDGs. Are we using the same word to describe activities which are inherently at odds with each other, or not? Can an investor’s definition coexist with other ideas of sustainability, or are the two incompatible?
In exploring the concept it is useful to use the commonly used three pillars of sustainability as a framework; Environmental, Social and Economic. Once broken down into these three elements, and in exploring how they may interact, we gain a greater insight as to whether investors are aligned to a broader understanding of the concept or not.
Investors are clearly motivated by identifying securities which are economically sustainable. Being able to identify companies which display characteristics of secure cash flows, a value enhancing management strategy and a sustainable competitive advantage are all key to finding investments which are likely to provide attractive economic returns over time. The concept of economic sustainability goes further than just the cash flows and business model, however, with good corporate governance, robust systems and strong policies needed to give assurance that the company is well managed. However, what if a company is able to offer such a profile but at the expense of the environment or society? In which case, can one sustainability pillar, in this case the economic pillar, dominate another or exist in isolation?
While there are plenty of companies which produce excess returns at the cost of the environment, their workforce or society, we would argue that these companies are not sustainable over the long term in any sense. Eventually the depleted environment on which such a business relies, or a disaffected workforce, would result in the company failing. Irrespective of the potential short term gains, one would expect a thoughtful, active fund manager to avoid such companies, as the turning point as to when they may start to decline and erode shareholder returns is difficult to identify. It is best, in our experience, simply not to invest at all.
By incorporating environmental and social factors alongside economic decisions in the process of selecting investments, a responsible investor would apply a triple bottom-line, affording each pillar a similar level of importance. While it may be argued that one or another pillar may be more important, it is true that the economic and society pillars are constrained by the environmental pillar. A company cannot operate beyond what the environment will allow and to this extent, the social and economic pillars could be de-emphasised relative to the environmental pillar, but not vice versa.
We find that those companies which display good environmental and social policies invariably make for a strong investment. And those companies which are able to demonstrate growth in cash flow, which are able to maintain a competitive advantage and which are well managed are often able to do so because they are environmentally and socially sustainable. To this extent the three pillars are complementary as one supports the other and the three work together to provide a more solid investment proposition.
As investors, we not only look for such a profile in a company, but encourage those companies in which we have an interest to pursue such an aim. This may be companies in which we are already invested, and are progressing towards greater sustainability, or companies in which we are considering an investment. The direction of travel is important and we are cognisant of changes which a company’s management may be implementing, which if executed correctly could materially enhance the outlook for a company’s prospects. In this way investors are able to influence and encourage improved behaviour, as a truly sustainable company is potentially good for returns as well as the environment and society.
Risk Warning: Past performance is no guarantee of future results and the value of such investments and their strategies may fall as well as rise. Capital security is not guaranteed.)
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