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Fri, 2 Sep 2022 | The Times of India
How sustainable is your sustainability?

How sustainable is your sustainability?

Authored article by Dhruv Maniyar, Assistant Manager (Research) and Parijat Garg, Fund Manager & Sr. VP at IIFL Asset Management


Charlie Munger, the legendary Vice Chairman of Berkshire Hathaway has famously said – show me the incentive and I’ll show you the outcome.

When it comes to sustainability efforts by companies, many believe they ought to be doing “right thing” irrespective of whether it translates into economic savings or advantages of other kinds. While this is an ideal outlook to have, we need to realize that this approach will always be linked to the profitability of a firm. The moment profitability is in jeopardy, sustainably takes a back seat. A stark example is the apparent pause on sustainability efforts in the EU, in the face of the Russia-Ukraine crisis.  In other words, without the right incentives, sustainability efforts may turn out to be unsustainable. We may need to look beyond moral imperatives and find real economic benefits to make sustainability truly sustainable.

The best opportunities are the ones where a transition to sustainability reduces the cost of doing business. For example, roof-top solar now offers a payback period of as little as three years. Companies that add roof-top solar to their energy mix are likely to experience a reduction in energy costs. While the impact may not be very large in most cases, it is a good example of a situation where doing the right thing is also economically beneficial. Similarly, efforts spent on waste minimization are naturally good for business as well.

Another source of value comes from risk reduction. For a business with considerable freshwater needs, it makes eminent sense to ensure water neutrality or even water positivity in its region. At the very least, not doing so jeopardizes its own capital investments in plants and equipment, not to mention risks the disruption of the entire business. If you are a cement manufacturer, a water crisis in your operating region is an enormous risk, and worth mitigating.

Another potential advantage could be on the revenue front. With consumer preferences shifting to sustainable consumption, the ability to offer sustainable products at reasonable prices can be a major competitive advantage. It is important to note, though, that sustainable products that cost a bomb are not likely to offer a big advantage. Hence there is a need for innovation to keep prices low while ensuring sustainability.

That still leaves several categories of actions where pursuing sustainability would be an economic negative for a business. There are almost always situations where the product or activity has negative externalities. Here the price is not paid by the producer or the consumer but by society at large. In these situations, businesses behaving responsibly face a non-level playing field. Doing the right thing may actually lead to higher costs, reducing profitability. Companies are not rewarded for their actions but are rather penalized by competition.

Here it is important for regulators to step in and force producers to pay for the externalities, levelling the playing field. This has been the case in mining for decades, where companies must provide for mining site clean-up at the end of the project. More of this needs to happen. Once the cost of externalities is forced onto producers, many more sustainability efforts become economically sensible.

As ESG investors, we need to think carefully about these incentives. On the one hand, we must push our companies to look for cost reductions, risk reductions, and business growth opportunities arising for sustainability. On the other hand, we must engage with regulators to ensure that negative externalities are correctly priced and charged to producers and consumers. This would create the right incentives for businesses to clean up their acts.

If we fail to find ways to make sustainability sustainable, we risk completely abandoning these efforts in the face of the smallest economic or geopolitical hardships.