The goal of companies' sustainability efforts cannot only be to avoid ESG scandals, says Professor Alex Edmans. Having a clear purpose generates new business and creates value for both society and shareholders.
The best companies contribute to society and create value for their shareholders, believes Alex Edmans, Professor of Finance at London Business School. That is why investors should also pay attention to the role companies take in the world.
“If you create value to society, society creates value to you,” Edmans summarizes his thinking.
Companies should aim for true impact
Many companies approach sustainability by focusing on risk mitigation, seeking ways to avoid economically, environmentally, or societally questionable activities that could harm their finances or reputation. According to Edmans, this often leads to prioritizing avoiding ESG scandals over genuinely impactful activities.
He believes a company's purpose can affect its ability to create value for its shareholders: “Often people think that ESG will eat into your returns. Purpose and ESG are ways to drive returns, not erode them.”
The British teleoperator Vodafone is a great example of this. The company’s money-transferring service, Mpasa, was a huge success in Kenya, where only a few people have an official bank account. The service not only enhanced the lives of hundreds of thousands of households but also proved to be financially lucrative. According to Edmans, the key is that this new service didn't originate from focusing on avoiding ESG-related harm but from a truly impactful idea.
For Edmans, this is at the core of a company's purpose: the idea is not to share the old pie in a new way between society and shareholders but to grow the size of the pie.
“If purpose is just about splitting the pie differently, then it's good for the society but bad for investors. It's about growing the pie through innovation, excellence, boldness, and coming up with some crazy ideas,” he encourages.
Purpose can lead to new business and improved processes
Edmans argues that a company's true purpose can be found in what the company does and is good at. While charity is also important, the greatest impact stems from the company's productive activities, innovation, and job creation.
“Ask yourself: what are the resources and the expertise my company has, and how can we use these to serve society if we think a little bit more creatively?” he encourages.
Finding the purpose in business is often financially profitable, as Edmans has discovered in his research. It can lead to developing new services and finding new clientele, as was the case with Vodafone, but it can also mean improving existing processes.
Hence, investors should pay attention to a company's purpose. Edmans, however, cautions that purpose can't be assessed using traditional ESG metrics or the opportunities for value creation found in lofty purpose statements.
“Measures like water usage or carbon emissions or employee injuries are not unimportant, but do they really capture the act of value creation? Growing the pie? Not necessarily.”
Investors can help grow the pie
Edmans says that Evli Emerging Frontier Fund and its analysts Burton Flynn and Ivan Nechunaev are shining examples of investors' role in advancing a company's purpose and reaping the benefits.
“As Burton and Ivan have shown, investors can guide companies to grow the pie.”
With an annual average return of 11.5%*, the fund has steadily outperformed its competitors by investing in high-quality companies from rapidly growing developing markets and actively participating in their development.
“It's very important to stick to a winning strategy, we believe, but we also think it's super important to adapt and to use new evidence to enhance the process, like how ESG can actually add value,” explains Flynn and refers to a study by Professor Edmans that showed how employee satisfaction correlates with positive stock price growth.
Discovering high-quality, rapidly growing but cheap companies requires a meticulous strategy and a lot of footwork. Flynn and Nechunaev have had over 3,000 meetings in 34 countries over the years.
These meetings have resulted in numerous stories – like the time when Flynn and Nechunaev woke up the finance minister of Pakistan from his daily nap – collected in the analysts’ blog. However, these encounters have also offered the duo invaluable insights into sustainability and growth potential that would have gone uncovered by reading yearly reports and financial statements alone.
The same level of effort continues after the initial investment decision. Flynn and Nechunaev have provided over 150 recommendations to their portfolio companies, spanning from enhancing investor relations to offering practical assistance, such as crafting more appealing investor presentations.
The data reveals the rationale for active involvement:
“The companies willing to engage with us were three times more likely to have their stock price double in 12 months after the engagement than those that have not engaged.”
Professor Edmans and Emerging Frontier Fund analysts Flynn and Nechunaev spoke at Evli's Grow the Pie – How Great Companies Deliver Both Purpose and Profit seminar in Helsinki in October.
* Historical returns are no guarantee of future returns.