This quarter, our newsletter highlights updates to our community college framework, rating agencies and ESG risk factors and increasing investor interest in sustainability.
Breckinridge started to systematically evaluate environmental, social and governance (ESG) factors as part our research process back in 2011.1 As noted previously, we have found that evaluating these factors, when material to the sector or company, provides us with a fuller understanding of the credit profile of our borrowers. Over the years, it has been validating to see how rapidly ESG integration has spread within the investment community.
In a recent Harvard Business Review article, authors Robert Eccles and Svetlana Klimenko make a compelling case that the growth in interest is being driven by six factors, including the increasing demand for sustainable investing strategies from asset owners.2 In their words, the groundswell of investor interest is creating “a new era of sustainable investing.”
The authors also highlight a disconnect: Companies increasingly understand the business case for sustainability but are not recognizing or acknowledging the intensifying appeal of ESG investing. This is confirmed by a 2016 survey of CEOs:
In response to the investor trend, which shows little sign of easing, the authors encouraged corporate management teams to take action in five ways, including:
- Fostering a richer level of engagement with shareholders (and we would add bondholders), which would include an articulation of their long-term plans,4 and
- Expanding involvement by middle managers in the identification and supervision of material ESG issues.
We agree with their assessment and recommendations. Despite the shortfalls, there are indications that companies are making progress in two important ways: 1) sustainability reporting, and 2) further integration of sustainability into organizational structures and roles.
Increased Adoption of Sustainability Reporting
ESG-related disclosure by companies has continued to rise in recent years. Measurement of the improved reporting is depicted in Figures 1 and 2. Figure 1 shows that the percentage of S&P 500 companies publishing a sustainability report jumped from 20 percent in 2011 to 86 percent in 2018. Early adopters, including United Parcel Service and Kellogg Company, were joined by more recent sustainability reporters such as Emerson Electric.5
Figure 2 also shows a substantial increase in ESG metrics, disclosed for the MSCI All Country World Index (ACWI), a global equity index. Disclosure for index constituents was in the 30 percent to 45 percent range for five metrics in 2010 and has risen to the 50 percent to 60 percent range in the latest available reporting (2017 or 2018). In addition, when looking at ESG data considered material to the sector, disclosure rates can be much higher. For instance, 86 percent of airlines in the index currently report their greenhouse gas emissions (GHG), a material issue for the sector.
Additionally, as we wrote last quarter, more companies are enhancing their sustainability disclosure by aligning with the Sustainability Accounting Standards Board (SASB) reporting framework. As of July 9, 2019, 73 firms (including Breckinridge) are SASB reporters versus 50 just three months ago. We also commented on how companies are developing carbon emission reduction targets that align with the consensus recommendations of the scientific community, a sustainability reporting best practice. Since our article from last April 2018, the number of companies either committing to or achieving a fully approved target has continued to increase (Figure 3).8
Integration of Sustainability into Organizational Structures and Roles
In addition to the improved disclosure, companies are adjusting managerial responsibilities and compensation structures, as well as adding resources, to drive sustainability improvements and to better communicate the initiatives to investors. For example, Ceres found in its “Turning Point” study that both management accountability for sustainability and executive compensation tied to ESG measures increased over a three-year period (Figure 4).
In addition, Ceres found that 38 percent of companies provide some form of training on sustainability issues for employees (Figure 5).
Finally, we’ve learned through our corporate engagements that investor relations (IR) teams are shifting responsibilities or adding new positions to better respond to ESG questions from investors. For example, we recently heard from a large U.S. energy company on how the CEO established a dedicated ESG investor relations team, to better tell the firm’s “nonfinancial” story. Last year, an investor relations representative for a major U.S. railroad told us that, given the increase in ESG-related questions, the company was looking to hire a dedicated ESG expert. These developments echo the recently published ESG disclosure policy statement from the National Investor Relations Institute. It states:
“ESG information is becoming increasingly integrated into the investment process by institutional and retail investors and encourages IR professionals to become more knowledgeable about the information and data that investors are seeking.”11
A New Era of Sustainable Investing
Management teams are increasingly embedding sustainability considerations into corporate strategies to drive operational improvements and product innovation. However, many have either not recognized or acknowledged the investor demand for better ESG information. As a result, communication between companies and investors remains challenged. Disclosure of ESG-related information is better but sustainability reporting lacks uniformity, which can affect the ability of investors to make true comparisons of ESG performance. In addition, companies are missing an opportunity to effectively convey the progress being made on sustainability initiatives and how they are creating value for investors. With the reporting and organizational enhancements and attention being paid by investors, we are hopeful that further improvement in ESG-related dialogues is just around the corner.
 For definitions of ESG and sustainability, which are often used interchangeably, please see this information from US SIF: https://www.ussif.org/sribasics
 Robert G. Eccles and Svetlana Klimenko, “The Investor Revolution”, Harvard Business Review, May-June 2019.
 The CEO study was referenced in “Sustainable Value: Communicating ESG to the 21st Century Investor,” Morgan Stanley Institute for Sustainable Investing, October 11, 2017.
 Breckinridge serves on the advisory board of CECP’s Strategic Investor Initiative (SII). SII encourages all public companies to commit to disclosing their long-term plans as part of annual investor reporting schedules. We discuss CECP SII in an ESG newsletter article here.
 United Parcel Service provides its corporate sustainability reports going back to 2002 on its website here, while Kellogg Company’s corporate responsibility reports starting in 2008 are available here. Emerson Electric published its first corporate social responsibility report in 2015, and links to the reports are available here.
 As of May 16, 2019. The report is available here.
 GS Sustain: Chart of the Week, “A glass-half-full view of ESG disclosure,” Goldman Sachs Equity Research, May 16, 2019
 For compliance and recognition, GHG reduction targets require approval by the Science Based Targets initiative.
 Kristen Lang, Jacob Robinson and Amy Augustine, “Turning Point: Corporate Progress on the Ceres Roadmap for Sustainability,” Ceres, February 2018, p. 9. Results based on the analysis of progress being made by more than 600 companies across 20 key expectations of sustainability leadership in the areas of governance, disclosure, stakeholder engagement and environmental and social performance.
 IBID, p. 10.
 National Investor Relations Institute, ESG Policy Statement, January 2019. Available here.
DISCLAIMER: The opinions and views expressed are those of Breckinridge Capital Advisors, Inc. They are current as of the date(s) indicated but are subject to change without notice. Any estimates, targets, and projections are based on Breckinridge research, analysis and assumptions. No assurances can be made that any such estimate, target or projection will be accurate; actual results may differ substantially.Past performance is not indicative of future results.
Nothing contained herein should be construed or relied upon as financial, legal or tax advice. All investments involve risks, including the loss of principal. An investor should consult with their financial professional before making any investment decisions.
Some information has been taken directly from unaffiliated third party sources. Breckinridge believes such information is reliable, but does not guarantee its accuracy or completeness.
Any specific securities mentioned are for illustrative and example only. They do not necessarily represent actual investments in any client portfolio.
BLOOMBERG® is a trademark and service mark of Bloomberg Finance L.P. and its affiliates (collectively “Bloomberg”). BARCLAYS® is a trademark and service mark of Barclays Bank Plc (collectively with its affiliates, “Barclays”), used under license. Bloomberg or Bloomberg’s licensors, including Barclays, own all proprietary rights in the Bloomberg Barclays Indices.
Neither Bloomberg nor Barclays approves or endorses this material, or guarantees the accuracy or completeness of any information herein, or makes any warranty, express or implied, as to the results to be obtained therefrom and, to the maximum extent allowed by law, neither shall have any liability or responsibility for injury or damages arising in connection therewith.