Sustainable investing What is the “G" in ESG?

Find out what "governance really means and why it makes a difference"

30 Nov 2018

Key takeaways

  • Sustainable investing goes beyond protecting the environment; investors may want to look out for businesses with strong corporate governance characteristics as well.
  • Investors focused on good corporate governance can screen for companies that include a balanced number of board members and a strong board composition; they may also consider oversight and conflicts of interest.
  • In the integrative approach to sustainable investing, investors can think of investing in well-governed companies as a way to mitigate risk.

Sustainable investing is growing in popularity and for good reason. Investors around the globe see sustainable investing as a way to do good and achieve competitive returns. However, it is important to understand that sustainability goes beyond protecting the environment; investors may want to look out for businesses with strong corporate governance characteristics as well.

Going beyond regulations

The US has limited regulations for corporate governance, but many companies choose to go beyond the minimums when establishing corporate governance guidelines.

"As an investor, you want good corporate governance to ensure that companies are being run well and through that, are being good stewards of your capital," says Andrew Little, Sustainable and Thematic Investing Associate in the UBS Chief Investment Office, Global Wealth Management.

"Investors have noticed that companies that just focus on the short term are missing out," he adds. "Businesses with strong corporate governance often have a long-term focus."

In some parts of the world, notably in Europe, there are stronger regulations pertaining to corporate governance. But even companies in the US may have reason to improve their corporate governance. "There are requirements to be listed on the New York Stock Exchange and other markets. These markets require companies to have certain governance guidelines in place," Little explains.

Boards of directors, executives and activist investors may work together to create goals on topics, including diversity, long-term goals and environmental targets, without losing track of performance and profits.

Filter out unsustainable companies through corporate governance

CEOs Warren Buffett and Jamie Dimon are well known and outspoken leaders when it comes to corporate governance. But it is important to search beyond the most famous examples to find companies with strong corporate governance characteristics.

"You're looking at the skills and experience of those on the board, and also diversity," Little says. "Empirical studies have shown that companies with more diverse boards lead to better financial results."

You can make this part of your investment process: Screen for companies that include a balanced number of board members and a strong board composition; also consider oversight and conflicts of interest. In the integrative approach to sustainable investing, you can think of investing in well-governed companies as a way to mitigate risk.

Keep your eyes on the board

A board of directors has broad responsibilities regarding the long-term financial health and viability of the company. "Financial transparency—coupled with third-party, independent auditing—signals effective corporate governance, potentially lowering the risk of improprieties," Little shares.

It is also important to consider how closely the chairman and CEO are aligned, and if they are the same person. "When boards are controlled by CEOs, you need to pay attention to incentive pay and general compensation structure. For example, if the vesting period for an executive's compensation is incredibly short, there is a possibility that their goals may be focused on the short term."

You can engage in a culture of responsibility by participating in proxy voting and exercising shareholder rights. "Empirically speaking," Little notes, "more shareholder rights and activism have historically equaled higher value, higher profits and stronger growth."

Adding corporate governance to your investment criteria

Sustainable investments, when managed the right way, offer both the potential for meaningful returns and a portfolio you can feel good about.

The next time you look to invest, be sure to review the corporate governance practices and goals of the companies you are thinking about investing in. If you incorporate a sustainable approach to investing in businesses, you may find yourself with a portfolio built for the long haul.