Business as usual is changing. Innovest, a strategic research group that tracks corporate performance on factors excluded by traditional accounting, has pulled the carbon thread out of the tangle of business activity and turned its research into a business tool.

It finds that companies acting on the carbon factor consistently post better results than their peers and that an analysis of how businesses manage it is a good predictor of overall performance. Across the world, leaders on this issue exceeded the financial performance of laggards by an annualised rate of return of 3.06% for the period 2004-07.

Innovest’s findings entitled Carbon BetaTM and Equity Performance suggest that managers ignore the carbon agenda at their peril. This is not just true in the heavy emitting industries like mining and utilities, but across at least 30 sectors, the company says.

Firm penalties
Penalties can be severe. In a notable case, mining company Xstrata listed on the London Stock Exchange in 2002, but dropped out of the FTSE-100 a year later. The listing details had failed to note the link between the company’s high exposure to coal, which is an intense greenhouse gas emitter, and regulatory risks. Some months after the IPO, the company was hit by a carbon tax in Japan and stocks fell by around 8% to 10%.

“The trick is to choose high-performing companies in advance. Our study is, inevitably, an ex post facto look at who did and didn’t outperform. Our study suggests that, as an increasingly robust proxy for strategic management quality in companies, carbon management is a good factor for investors to consider,” asserts Innovest chief executive Matthew Kiernan.

That linkage exists, he suggests, because the risks and opportunities related to climate change are rising. Risks are not confined to regulation, but also include energy prices and market shifts while opportunities include new product development. If the International Energy Agency’s predictions for 2030 are correct, greenhouse gas emissions will have jumped 57% from 2005 levels by 2030 under its reference scenario.

Under its alternative scenario, global emissions will be 27% higher in 2030 than in 2005, and will stabilise by 2025. Both scenarios confirm the new agenda, the first because scientific studies suggest higher temperatures will cause greater damage. The intriguing question is at what point corporate action on carbon emissions will become business as usual, as fully integrated into management thinking as corporate governance or pensions funds.

Innovest’s research points to the fact that most businesses are still off the rails on this issue, though this may be truer in the US. Xstrata’s blunder may have happened nearly five years ago, but it could still happen today, at a time when most carbon legislation has yet to hit home. Businesses in the same sector are exposed to the risks to a different extent, says Kiernan, depending, for example, on the countries where they operate. Individual sectors, meanwhile, show different levels of sensitivities to the risks and opportunities.
The research, which goes beyond assessing disclosure levels, should be viewed as a complement to conventional equity research, but it is also an attempt to reframe business.

Qualitative view
The company accepts that the reverse of its conclusion is not necessarily true – in other words, some companies are still doing very well financially without considering the eco-efficiency scenarios, but for how much longer? Most of these issues are still externalised by companies and most London-based investment banks take a qualitative view.

“Companies that are well run have more time and money to invest in this,“ says an analyst at JP Morgan who is not surprised by the findings and who does consider these questions when rating companies. Others, though, view sustainability as a public relations issue and the risk as reputational. But as carbon costs become quantified through the cap-and-trade scheme in operation in the European Union and around the corner after the US elections, the links with financial performance will become more visible.

The Association of Chartered Certified Accountants says that the financial valuation of emissions is likely to be the final outcome of the drive to improve environmental transparency through better disclosure. That, in turn, will influence strategic decisions and perhaps usher in the era of environmental economics.