Sustainability is fast turning into an investment criterion for asset managers, banks, private equity firms, development finance institutions and individual investors – with net gains reflected in better managed risks, improved returns and more accurately priced assets.
This trend has been highlighted by the Sub-Saharan Africa Division of Environmental Resources Management (ERM), global leaders in sustainability consultancy. Donald Gibson, a partner at ERM in Johannesburg, says sustainability’s role as an aid in value creation is now so well accepted internationally that ESG (environmental, social and governance) has become a catch-all term in capital markets for corporate behaviour likely to influence company valuations and share prices.
Gibson says ESG impacts are felt across the investment cycle – pre-investment, acquisition of a targeted asset, on-going operations, pre-disposal and exit.
Within the asset management industry, he points out, ESG is evolving into an investment style known for volatility mitigation while delivering acceptable portfolio returns.
Says Gibson: “ESG has become a significant growth area as the importance of sustainable solutions has been grasped by companies, investors and fund managers looking to unlock short- and long-term value.
“Investors hate uncertainty and unforeseen risks. ESG measurement addresses these issues while enabling investors or business buyers and sellers to develop an accurate picture of risks and obstacles to the realisation of optimum value.”
ESG focuses on areas such as energy and water efficiency, carbon emissions, occupational and community health and safety, jobs, absenteeism and staff turnover, compliance risks, ethics and governance and potential revenue from product innovation. Measurement of these areas permits the development of metrics for use in financial analysis.
In addition, ESG scores have an increasing role in determining the cost of capital.
“Poor ESG management tends to increase risk exposure,” Gibson explains. “Elevated levels of risk clearly affect a corporate borrower’s ability to manage debt. One result is higher interest rate charges for poor ESG managers while lower rates reward better ESG outcomes.”
ESG measurement is not only used in company acquisitions and disposals in South Africa, but across Africa.
“A growing number of local businesses see the benefits,” says Gibson. “ESG enables informed decisions and risk assessments. This can be monetized. Results are seen in the purchase or disposal price during M&A activity or through long-term improvements in corporate earnings that ultimately make it into a company’s share price.“This explains ESG adoption by local companies, and, of course, many South African corporates are striving to widen their African footprints; which means that businesses deploy these same metrics when cross-border acquisitions or partnerships are contemplated.
“Thorough due diligence assessments rely increasingly on ESG, and importantly link ESG liabilities and opportunities to the drivers of business value.”
In one recent acquisition, ESG measurement alerted the deal team to potential risk factors, resulting in a discount of $400 million on the envisaged purchase price.
Gibson concludes: “When the ESG difference runs into six figures in just one deal, the value of sustainability as a criterion for investment becomes clear enough.”