Sustainability issues are linked to long-term value

Superannuation funds are legally obliged to act in the best financial interests of their members. The ‘best financial interests duty’ requires trustees to exercise their duties and powers in a way that acts to enhance the long-term value of the savings entrusted to them. Financially material sustainability risks and opportunities affect these retirement savings, although not all sustainability risks are material for every company. ACSI considers financially material issues to be those that could be reasonably expected to affect a company’s financial performance over the short, medium, or long term.

Overview of research

Existing research, including academic papers, meta-studies, and insights from governance advisors, supports the conclusion that sustainability issues are financially material. The evidence suggests that incorporating these factors into investment practices is beneficial. While some studies do not support the same conclusions, they are fewer in number. Furthermore, evidence indicates that investor engagement with companies on sustainability issues is financially beneficial, reinforcing it as a key approach to protecting and enhancing value for superannuation members.

Research on all sustainability factors

Numerous global studies demonstrate the financial relevance of sustainability factors. A 2021 meta-study of over 1,000 separate studies identified a positive or neutral correlation between ESG factors and financial performance in 71% of the cases analysing corporate performance measures. For studies assessing risk-adjusted measures like the Sharpe Ratio, 59% found a positive relationship, while only 14% demonstrated negative results. This research also found that performance improvement is more pronounced over the longer term and that ESG integration performs better than other strategies.

Further evidence includes a 2015 meta-study of more than 2,000 studies, which found a positive or neutral relationship between ESG integration and financial performance in 90% of them. A 2019 study identified that top ESG-ranked companies outperformed equal-weighted S&P 500 companies. Conversely, a 2021 study found that portfolios with a greater number of negative ESG incident rates, such as environmental pollution or poor employment conditions, underperformed by 3.5% in the US and 2.5% in the EU per year. Additionally, incorporating ESG information was found to result in an 11% higher realised Sharpe Ratio.

Research on governance factors

Good governance requires boards to oversee material sustainability risks, including risk management, capital allocation, and board composition. A 2019 study found that applying the UK Corporate Governance Code drives value, with stronger governance generating and retaining more value. Gender diversity is also linked to performance; global research found that companies with one or more female board directors outperform those with none. In the Australian context, 2020 research found that boards with more than 90% male directors have underperformed compared to boards with at least one woman since 2011.

Other findings include a 2019 study on MSCI’s ‘AGR’ governance rating, which found that a portfolio of better-governed firms generated a risk-adjusted return of approximately 5% per year. Research from 2024 on CEO succession found that mandating succession plans would increase shareholder value by 3%.

Research on environmental factors

Climate change and the associated transition entail significant financial risks. A 2019 study of 13,000 firms found that increasing exposure to extremely high temperatures reduces revenues and operating income. A 2020 review of climate change studies reported that 57% of those focused on corporate performance measures showed positive outcomes. Beyond individual firms, environmental issues pose systemic risks. It is estimated that leaving climate change risks unchecked could reduce Australia’s GDP by 6% by 2070, while biodiversity loss could wipe up to US$20 billion from the Australian economy annually by 2050.

Research on social factors

The ‘social’ factor incorporates issues such as workforce management, corporate culture, safety, and diversity. A long-term study found that companies listed in the ‘100 Best Companies to Work For in America’ generated 2.3-3.8% per year higher stock returns than peers. A 2024 study found that companies with the highest degree of LGBTQ+ transparency had average profit margins more than double those of companies with the lowest scores. Systemic social risks are also significant; eliminating work-related injuries or illnesses would generate an average 1.6% increase in Australia’s GDP, while mental ill health costs the economy an estimated $200-220 billion per year.

Active ownership on financially material issues

Strong stewardship involves engaging on material issues to protect or enhance returns. A 2024 study reported that successful engagement on sustainability issues led to a 9% decrease in the value-at-risk of target companies relative to control groups. A 2015 study found that successful investor engagements with US public companies generated a cumulative size-adjusted abnormal return of 7.1% in the following year. Collaborative engagement initiatives have also been shown to improve annual abnormal stock performance and accounting measures like return on assets over a three-year period.