Investing: Understanding non-financial risks
Unfortunately, in New Zealand, the focus is largely on only one part - “Negative” exclusions. This involves removing companies in a portfolio that are involved in egregious industries, for example, controversial weapons, gambling, tobacco and thermal coal. This is a good first step but it's not enough. Going beyond exclusions, investors can use current controversies and Environmental, Social and Governance (ESG) scores (positive factors) to better understand future non-financial risks.
Research says using ESG works. A 2016 report by Bank of America Merrill Lynch found that investing only in the above average ESG scoring companies helped avoid 15 of 17 bankruptcies in their US stock universe, since 2008. While we’re not talking bankruptcy, Facebook is another real-world example of ESG scores helping to understand a business.
The Facebook example
Facebook has had a howler of an earnings season. A 42% growth rate in revenue would be a miracle for most companies but for Facebook, a high growth company with temperamental shareholders, it is the first guidance miss since 2015. Daily and monthly user numbers are also slowing, whilst its cost of business is expected to increase faster than revenue this year and into 2019.After two years of negative headlines, data breaches and election meddling, shareholders had finally had enough. Facebook’s share price reacted to this negative news flow in late July – losing 18% in a single day. Losing US$120 billion is a lot, that’s more than the total market capitalisation of New Zealand.
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