When we pick a stock to invest in, we make assumptions about how the company is being managed and what its value is. We determine that the CEO isn't taking wild risks that could run the company into the ground, and we estimate the value of the company based on measurable things like its physical assets, as well as intangible things like its reputation.
Bruno Bertocci, managing director of UBS Global Asset Management's Sustainable Investors Team, makes the case for the new standards being developed in the US by the Sustainability Accounting Standards Board, or SASB. He says since investment analytics have evolved to include intangible, yet material, facets of a company that are not governed by financial accounting standards, corporate disclosure should be extended to these facets and particularly environmental, social and governance (ESG) factors. And they should be standardized.
"Sustainable investing, the way we see it, is really just an evolution of traditional fundamental investing," he said on a recent webinar. "We think that in 10 years we won't be having this kind of discussion; we'll just take it for granted that we should be looking at this kind of information."
Bertocci points out that investment analysis as we know it is based on a 1934 book called "Security Analysis" by Benjamin Graham and David L. Dodd. The process that made sense to use in the 1930s was a mosaic of financial analysis, valuation, qualitative assessment, and management interviews. "This analysis is about figuring out what the brick and mortar and the machinery and the inventories and the accounts receivable are worth and subtracting the debt, and you've got a book value," says Bertocci. "In 1934 a company's book value and its market value were highly related, because that's how people thought about valuation," he says. "But a couple of things have changed in a big way since the book was written."
Bertocci cites a study by Ocean Tomo, an intellectual property advisory firm, showing that intangible assets amount to 84% of the market value of companies today, many of which now sell services rather than goods, compared with 17% in 1975.
Intangible sustainability factors are important to look at because they affect costs, as well as quality and productivity. From an asset manager's point of view, "we believe that the proper use of sustainability or ESG factors enlarges your view of the company you're investing in, helps you manage risk, and is going to be helpful to you in identifying companies that are going to deliver excess returns for your clients," says Bertocci.
So today what is needed is an extension of the old mosaic to include, in addition to all the financial analysis which is still valid, material non-financial factors, and shared value.
"Shared value," a phrase coined by Harvard Business School professor Michael Porter, refers to the interconnectedness of the health of a company and that of the community it is a part of. And there are inevitably non-financial factors contributing to the overall value of a company, making it usually worth a multiple of its book value. In fact it has long been a requirement for listed companies to disclose anything to the SEC that would influence a reasonable investor, whether quantitative or not.
Sustainability factors to look at include energy and water use, worker safety, employee skills, and supply chain risk, among many others.
Bertocci points out that sustainable investing has in fact been around for some time. It started with "negative screening"; he gives the example of Quakers, centuries ago, vetoing the use of their funds to finance ships involved in the slave trade. Today asset managers are more likely to screen out tobacco, weapons or fossil fuel companies, or companies with poor human rights records. Later sustainable investing evolved to include "positive screening": selection of companies that stand out as good corporate citizens.
But the point is this: in the future, sustainability analysis won't be separate from financial analysis of stocks. It is simply an add-on for modern times, a way of looking for a more complete picture of a company rather than one that separates the company from its context and only looks at its quantifiable assets and liabilities. We are no longer in the 1930s, and it is time for financial analysis to graduate to the next step.