Change for the better Change for the better http://www.federatedinvestors.com/static/images/fhi/fed-hermes-logo-amp.png http://www.federatedinvestors.com/daf\images\insights\article\light-bulb-changing-small.jpg March 11 2022 March 8 2022

Change for the better

Companies ignore the ESG movement at their own risk. 

Published March 8 2022
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It’s hard to name a more compelling example of corporate transformation than General Electric’s (GE) exit from the lighting business. Lightbulbs launched Thomas Edison’s company in the late 1800s. For much of the 20th century, the GE brand was synonymous with quality consumer appliances and electronics. As dynamics shifted in the 1980s, famed CEO Jack Welch divested its market-leading GE/RCA television business and made a regrettable pivot to financial services. That was dealt a mortal blow by the 2008 Global Financial Crisis. Today, GE’s only link to the innovative lightbulb is its cursive logo, and the conglomerate is splitting into three separate corporations in the aviation, health care and power sectors.

Change is essential to business, but an organization doesn’t need to reimagine itself to move in a positive direction. Adaptation is often the wiser choice. This is the challenge facing management and boards today when it comes to the issue of corporate sustainability. Will they meet the desires of customers, governments, investors and other stakeholders increasingly demanding businesses operate responsibly with greater transparency captured in the ever-expanding environmental, social and governance (ESG) movement? If companies realize the threats a lax attitude can have toward changing consumer preferences and regulations, they should view them as a real long-term business risk.

Once properly vetted, a key action is to establish a governance system to manage relevant and material ESG risks. Some companies form committees, but an increasingly popular practice has been to establish a sustainability team. These have proliferated in recent years, usually headed by a chief sustainability officer who has a seat at the proverbial table and determines strategy with the rest of the senior leadership.

But corporate evolution is not complete until real money is spent. Enter the finance department. It’s here that the costs of implementation are quantified, and they can be formidable. A plan to reduce a company’s carbon footprint can lead an organization to anything from retrofitting facilities to revamping production. Upgrading data security and addressing environmental impact can carry upfront expenses. Capital must be allocated effectively to create the sort of intellectual property that can fuel growth in our knowledge-based economy.

In an effort to finance their transition to greener pastures, many businesses are issuing a new type of bond linked to their long-term sustainability targets. According to the Institute of International Finance (IIF), issuance of sustainability-linked bonds is on track to exceed $1 trillion this year. By turning to green financing sources, companies are making an agreement with their investors that meeting specific ESG key performance indicators, such as decarbonization targets, will lead to a lower cost of capital. 

Once the board and senior management come to the realization that sound ESG practices and solutions have a material impact on revenues and risk, the mindset shifts from “ESG is a fad” to “ESG is our future.” It comes down to having the fortitude to establish a forward-looking vision. Companies committed to a transition have to make uncomfortable and sometimes unpopular strategic decisions to establish a sustainable business model. Nonetheless, judging by its growing acceptance, sustainability may soon become a core business function.

Tags Responsible Investing . Markets/Economy .
DISCLOSURES

Views are as of the date above and are subject to change based on market conditions and other factors. These views should not be construed as a recommendation for any specific security or sector.

Terminology such as “ESG integrated,” “sustainable” or “impact,” among other terms, is not uniformly defined across the industry. Investment managers may understand and apply ESG factors in different ways, and that the role those factors play in investment decisions also varies. Therefore, we recommend investors understand the role of ESG factors in a strategy to ensure that approach is consistent with their investment objectives. Like any aspect of investment analysis, there is no guarantee that an investment strategy that considers ESG factors will result in performance better than or equal to products that do not consider such factors. Investing and making buy-and-sell decisions that emphasize ESG factors carries the risk that, under certain market conditions, the fund or strategy may underperform those that do not incorporate such factors explicitly into the decision-making process. The application of ESG criteria may affect exposure to certain sectors or securities and may impact relative investment performance depending on whether such sectors or securities are generally in or out of favor in the market.

 

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