Some of the largest and most influential institutional investors and asset managers are at the forefront of a powerful movement to add environmental, social, and corporate governance (ESG) standards to their criteria for capital allocation. As long-term stewards of capital, they recognize a mandate to consider whether the companies they own today will maintain a strong connection both with their customers and extended communities as environmental and social challenges increasingly impact the way we live and work. They also recognize that companies that commit to addressing these urgent issues stand to realize greater business opportunities in the future—and thus will achieve higher returns for their long-term shareholders.

Institutional investors that are best poised for the future are those that actively engage with companies through the “power of purpose” instead of simply liquidating their shares and walking away from positions they perceive as questionable in the new climate. Such investors are far better placed to push their holdings in the direction of long-term sustainability through such measures as voting proxies and shareholder resolutions—or by initiating open dialogue with company leaders. Private sector companies and investors that follow this strategy can carve out a far more active role for themselves in the quest for diversity, environmental sustainability, and other important societal goals.

Two trending developments are motivating large investors to embrace sustainable finance and to engage directly with corporate executives and boards:

1. The ubiquity of information about corporate practices. This availability is shining a light on the roles that companies play in shaping the environment and making clear the pivotal role that the private sector will play in finding solutions—or not—to problems such as climate change. Much if not most innovation today occurs within the context of companies, whether startups or incumbents, adopting policies that deliver a positive impact. This is likely to remain the case.
2. The mounting evidence that addressing ESG issues does not hurt financial performance. In fact, companies that are proactive on issues such as diversity, climate stabilization, and consumer responsiveness can deliver substantial financial rewards.

Total societal impact (TSI) is a framework that companies and investors can use to diagnose specific levers that drive both total shareholder return and societal impact. BCG recently used TSI to study the relationship between, on one side, performance on ESG issues such as inclusive supply chains and environmental impact, and on the other, market valuation multiples and margins. BCG found that ESG metrics were statistically significant in predicting the valuation multiples of companies in all the industries it analyzed. Moreover, investors rewarded the top performers on specific aspects of ESG with multiples that were 3% to 19% higher, all else being equal, than those of the median performers. Top performers on some issues had margins up to 12.4 percentage points higher.

This contrast is likely to become more dramatic over time as sustainability considerations move closer to the bottom line at many companies. When Pacific Gas & Electric, the largest US utility, filed for bankruptcy in the wake of California’s catastrophic wildfires, it cited climate change as a material cause of its petition. It was the first time that climate change was specifically cited in such a context.

To guard against exposure to such events, investors understand that they can no longer treat sustainable financing as a niche practice. Asset managers, too, are increasingly shifting from policies that seek to avoid risk by excluding specific securities, in favor of strategies aimed at benefiting from companies that perform better on TSI issues. Examples include best-in-class and thematic investing; impact investments, such as low-carbon indices and green bonds; and seeking out companies that score well on gender diversity.

These are still early days, however. Soon, we are likely to see sustainable financing morph into a more integrated, intentional approach. Investors will apply ESG integration and best-in-class analysis across all categories of assets in order to enhance their risk and return performance. Active ownership, too, will become an integrated model, with investors routinely engaging with boards and CEOs on companies’ efforts to increase diversity and address their environmental performance, just as they do now on executive compensation, corporate governance, and shareholder rights. Norms and negative screening will be used to inform engagement, not trigger exclusion.

Driving these developments is the increasingly critical role that private sector companies will play in addressing climate change, diversity, and other important societal issues—with large investors pushing them along this positive path. However, translating this investment strategy into tangible financial results for shareholders, both in the short and long term, requires insights into the steps that companies must take to heighten the impact and sustainability of their business models.

BCG's consultants and industry experts focusing on socially responsible investing continue to partner with leading investors, asset managers, and private sector companies to support sustainable investment practices. These are some of our experts on this topic.