Does the Market Value Sustainability?
Held at McKinsey & Company
Monday 9 July 2001

The Sustainability Business Forum is organised by the Corporate Sustainability Project at the Faculty of Business, University of Technology Sydney. This was the second occasion that the Forum has met and it was hosted by McKinsey & Company. Following are rough notes taken during the session.

Michael Anderson AMP
Head of Social Responsibility Funds

The market increasingly values sustainability. The business paradigm of the 70s was 'make money by reducing internal costs and by externalising costs.' Greater enfranchisement and population growth in the third world has heightened awareness of limited resources and has led to concerns about the future. There is anger about waste and increased concern about the impact of affluence in threatening the quality of life this has identified a need for dematerialisation. Social obligation in the seventies was seen as a threat it is now seen as an opportunity.

Tobacco companies and others with a negative public image are paying employees approximately 20% more in order to get people to work for them (Sydney Morning Herald 21 April 2001). It is increasingly costly to operate companies which are not socially responsible.

Fig. 1. Adoption of EC environmental legislation is increasing dramatically

Sustainability is a criterion for identifying the industries of the future, such as renewable energy, information technology, education, health care, water and waste management.

Fig. 2. Companies aligned with sustainability

Fig. 3. Corporate Social Responsibility involves shareholders and partnership between the environment, community and employees

Fig. 4. Environmental and social analysis

Socially Responsible Investment (SRI) issues straddle two worlds. Companies always need close monitoring and transparency to determine how grey or green they are. Two approaches are used to consider these issues: best of class vs industries of the future. However, there is no such thing as a 'best of class tobacco company.'

Fig. 5. Portfolio construction

How do you assess the appropriateness of a company for investment? Talk to as many stakeholders as possible and consider how much to disclose? Disclose the portfolio on the web accompanied with a description of each company. In terms of assessing companies a decision is made between screening them and engaging them; AMP has chosen to engage them and thereby influence them. Sustainability is integrated into AMP's analysis and sustainability is viewed as more than a sample screen; it is seen as a commitment to constructive dialogue.

Portfolio construction raises the question of whether to use passive or active financial analysis. SRI investments do better. But, what do you do if you decide not to invest in a company like News Corp when News Corp is 12% of Australian funds? For AMP sustainability is a driver of share funds. It is integrated into our social, environmental and financial analysis. We don't simply screen funds, we make a commitment to ongoing constructive dialogue.

Frances Grey
Sustainability Asset Management (SAM)

The Dow Jones Sustainability Index is the leading global index. The Company started in 1995 on the Zurich Stock Exchange founded on venture capital. SAM was established as a joint venture with Dow Jones in 1999 and tracks the 10% top sustainability companies in each industry worldwide. The original company owns 50% and Dow Jones owns 50% in a joint venture to create an index of sustainable development. Non-financial performance accounts for 35% of institutional investors' valuation. 'The more sell-side analysts rely on non financial indicators, the better the performance.' There is a consistent set of non-financial drivers analysts rely on:

• Strategy execution
• Ability to attract talented people
• Quality of strategy
• Management experience
• Innovativeness
• Research leadership
• Quality of major processes
• Quality of executive compensation
• Management credibility
• Market position

The Dow Jones and other Sustainability Indexes account for US$6 trillion of investment. Maximising shareholder value oversimplifies the business world. We ask what is good for this society and we invest in that.

Global Sustainability Trends consist of social-cultural trends, environmental and economic trends. These can be broken down into sub areas for example social -cultural trends includes: transparency, healthy living, urban lifestyles, tribal lifestyles and ethical life styles. Environmental trends includes: ecological risk awareness, dematerialization, global warming and scarcity of natural resources. Economic trends includes: speed, technological change and innovation, lifelong learning, intellectual capital and virtual working.

Rating criteria

We will, for example, recommend investment in Dow Chemical Company because it is regarded as the sustainability leader in the chemical industry outperforming the industry dramatically.

Fig. 6. Dow Chemical Co.: Sustainability leader in chemical industry

Leading sustainability companies

European companies are over represented in the fund and yet the fund has outperformed others despite US companies growing faster overall. It has outperformed on average ROE, average ROI and average ROA.

Fig. 7. DJSGI World vs DJGI

Fig. 8. DJSGI characteristics

The index had 16 licensees in March 2000 it now has 26. SAM aims to become the benchmark in this area. How is the financial sector responding? There is a great deal of interest that was not there before, as that sector realises that sustainability picks up more fundamental issues about the company than finance alone.

Bruce Thomas Swiss RE
Head of Re-Insurance and Risk

'Companies that adopt sustainability principles have the best chance of success in the long term,' (Bruno Porro, CRRO). The latest estimates are that there is a $60 billion liability in US for asbestos. Swiss RE has been involved in the climate change debate since early 1990s. Climate change has had a dramatic impact on re-insurance. The world is experiencing more natural catastrophes. Of the 15 most costly events over the last 30 years all but three were weather events. Of the 12 weather events, ten occurred in the 1990s and of the ten, four occurred in 1999.

The 15 most costly insurance losses 1970-2000

Conclusions:
USA and Caribbean: no increase
Australia: dramatic increase in incidence and cost
Is this a function of better reporting? In fact there were only ever three Category 5 cyclones on Australia land: one in 1989 and two in 1999.

What explains this change in the incidence of major losses?

• Are storms more severe and more frequent? or
• Is the insured property more valuable? or
• What is the effect of population changes? Parts of the world with the most rapidly growing population appear to be most exposed to natural catastrophe.

During the period 1900-2000 there has been a dramatic increase of the incidence of category 4 and 5 cyclones in Australia. However there have only been three category 5 cyclones on land in Australia: one in '89 and two in '99. There is an increased cost for insurance from climate related catastrophes and these events are occurring in new locations.

Category 4 and 5 cyclones

In Australia (PerilAUS -NHRC Macquarie University):
1900-09   2
1910-19   4
1920-29   2
1930-39   2
1940-49   0
1950-59   1
1960-69   4
1970-79   5
1980-89   2
1990-99   7