Sustainability: The Walden Investment Perspective

by Lucia Santini, CFA

From the Summer, 2007 issue of Values

The word sustainability seems to have eclipsed most other investment buzzwords in use and popularity recently. Scores of companies, from American International Group to State Street Corporation, have devoted countless glossy pages to trumpeting their commitment to sustainability, but what does sustainability mean, really? If you are an aficionado of words and usage, you will scorn the verb turned noun and expect that no self-respecting dictionary will acknowledge its existence. Walden may even harbor a few such purists. As to sustainability as a concept, however, the search for companies with attractive characteristics encompassing financial, environmental, social, and governance dimensions (the latter three often grouped as the acronym ESG) has been a core pursuit of ours for over three decades.

Some people define ethical behavior, environmental stewardship, and social responsibility as distinct and separate criteria which, together with economic viability, may combine to achieve the coveted sustainability label. Are these concepts truly so separable? As a long-term investor, Walden has always been skeptical that economic viability can be achieved and preserved in the absence of such factors as ethical behavior, environmental stewardship, and social responsibility. The risks and negative consequences of unethical behavior, environmental abuse, or socially undesirable business practices have a cost we constantly integrate into our analysis of value. Conversely, attention to ESG factors places forward-looking companies in a better position to capitalize on business opportunities.

At Walden, the search for high-quality, reasonably-priced companies that possess a sustainable business model is a fundamental duty for analysts and portfolio managers alike. The focus on sustainable business models marries Walden’s “conventional” investment analysis with our ESG research and advocacy focus. Our analytical process provides the tools and the long-term focus required to identify companies whose business (i.e., products and services) and business practices combine to offer the sustainable advantage we seek.

Walden has focused on sustainable advantage and sustainable development for more than 30 years. In a 1994 issue of Values we noted the link between economic justice and sustainable development. “Socially responsive investors are intensely concerned with the . . . issues of sustainable development: creating and maintaining good jobs and wholesome communities, making our social system more durable by adding to the fairness and justice of its outcomes, sustaining the natural environment on which all life and development depends, and increasing the time horizon for considering the consequences of economic decisions.” We continue to believe companies that demonstrate the integration of these sustainability concepts to have a business advantage.

What tools do we use in our search for companies with a sustainable advantage? Our financial analysis focuses on current and long-term profitability; leverage; consistency of sales, earnings, and cash flows over time; and the quality of earnings. Financial engineering, as evidenced by aggressive pension assumptions, significant gain on sale accounting, frequent charges or write-offs, or a significant increase in debt (among other things) are clearly not sustainable, meaningful sources of earnings growth and increases in cash flows. Similarly, companies operating in an increasingly competitive environment with low barriers to entry will find any advantage difficult to sustain. Can this view of sustainability exist independent of and distinct from our ESG analysis? We don’t believe so.

The diagram below, Walden’s Sustainable Investment Process, highlights the integration of Walden’s research and analysis on financial and ESG topics. To find suitable long-term investments for the portfolio, Walden analysts consider these fundamental aspects of a company’s performance and profile. The first two aspects, Profit Growth and ESG Analysis overlap meaningfully as we consider sustainable advantage. The third critical input, Valuation, represents our quantitative and qualitative long-term value model used to determine an attractive price.

While others often regulate ESG analysis to the dusty corners of securities research, Walden prioritizes these topics in the belief that they are intimately linked to long term value. Key among them are transparency and disclosure to the public and shareholders. Strong corporate practices regarding transparency and disclosure are fundamental and critical to financial analysis as well. How can we be confident in the quality of a company’s earnings in the absence of clear, consistent disclosures regarding both qualitative and quantitative aspects of the company, its operating environment, and business practices?

Walden has long worked to understand the links between financial and ESG topics as the following excerpts from past Values demonstrate.

Can companies with boards and senior management teams bereft of women and minorities operate a sustainable business model? As we noted in a 2006 issue of Values, the negative ramifications of persistent inequalities in the workplace pose risks not only to society, but also to long-term business success. . . . Customers are becoming increasingly diverse. A representative workforce is apt to anticipate and respond effectively to evolving consumer demand. . . . Conversely, allegations of discrimination in the workplace have created a significant burden for shareholders due to the high cost of litigation and potential loss of government contracts.

In a 2003 edition of Values we highlighted the issue of climate change and the Carbon Disclosure Project, and noted, Climate change creates unpredictable, extreme weather, greatly impacting water resources, agriculture, and habitats, and creating flooding, drought, and desertification. . . . As with so many environmental problems, the impacts may be disproportionately felt by the poor, who have limited resources to adapt.

Clearly, the link between a company’s operating environment and stable, uninterrupted business processes cannot be overlooked. In addition, we noted the economic justice and resource issues inherent in global warming. To long-term investors, these must be critical considerations in the assessment of value.

Staples, a holding in many client portfolios, provides a case in point. The office supply superstore combines an attractive financial profile of superior sales and earnings growth, stable financial position, and strong earnings quality with an industry-leading environmental profile and strong employee benefits. Staples pledged to increase the average post-consumer recycled content in its paper products to 30 percent, and to source 10 percent of its energy from renewable sources. Its benefits package is attractive and it has developed “Staples University” to provide employees with additional skills and training. In recent years Staples has increased its disclosure and transparency markedly.

Shareholder Advocacy is the final component featured in Walden’s Sustainable Investment Process diagram. A core focus of our work as sustainable investors is to encourage greater corporate disclosure on key social, environmental, and governance issues. In addition, when we are able to make a clear business case for modifying company policies or practices, we will advocate for these changes. As examples, we have encouraged companies to decrease their greenhouse gas emissions, make their non-discrimination policies more inclusive, and increase the diversity of and opportunities for their employees. We have done so believing that these changes increase the sustainability of a company’s business model.

For Walden, the commitment to the sustainable business model, sustainable development, and sustainable advantage--to wit: sustainability (the non-word)--is longstanding and is evidenced by our relationship with the companies held in client portfolios. Long-term value is created by the development of superior products and services which have incorporated financial, social, environmental, governance, and strategic policies and practices. This commitment and approach has been at the core of our work for decades.