On Economic Rationale for Sustainability

This has been a year of many elections around the world. Looking back, it seems that support for populist policies has increased around the world. In the US, we can expect significant changes in US policy following Trump's victory in the presidential election. One concern is that short-term issues, such as economic stimulus, will be prioritized and medium- to long-term issues, such as addressing climate change, will fall off the policy priority list. A softening of environmental regulations or a reduction in government support could create a headwind for action on global warming.

However, even if the political situation lacks stability, listed companies are unlikely to stop taking sustainability measures such as initiatives to address issues and disclosure of related information on climate change, human rights and other issues. As the disclosure of sustainability information becomes institutionalized around the world, it is expected that listed companies in particular will steadily take steps to establish such a system. In Japan, the Sustainability Standards Board Japan (SSBJ) is promoting the institutionalization of sustainability disclosure based on the international ISSB standards. Discussions are underway on a schedule under which companies with a market capitalization of 3 trillion yen or more will disclose sustainability information in accordance with SSBJ standards from March 2027, and third-party assurance will be provided from March 2028. Based on this standard, the SSBJ standard will be gradually applied to companies with a market capitalization of 1 trillion yen or more one year later, to companies with a market capitalization of 500 billion yen or more the year after that, and so on. Details will be finalized by the end of March 2025.

Under these circumstances, what do we need to do as investors to achieve both sustainability and returns? First, it is important to support the sustainability efforts of investee companies through investment and dialogue, without being influenced by changes in the external environment. In addition, we believe it will become even more important to consider the economic rationale for sustainability.

By economic rationale, we mean whether or not sustainability measures have a positive effect on a company's financials. For example, energy-intensive industries such as materials and commodity industries need to invest large amounts of money to mitigate climate change, but at the same time it is difficult to raise prices through product differentiation, so sustainability tends to have a negative impact on business performance. If the government makes the benefits of action (or the disadvantages of inaction) clear through subsidies and stricter regulations, the economic irrationality will be removed. For the time being, however, it may be difficult to expect political leadership to remove the irrationality.

On the other hand, companies with highly differentiated products and services, such as consumer goods and high-tech equipment, have a strong business case for sustainability measures. If they can enhance their corporate and product brands through climate change measures and human capital investments, they can expand their customer base and increase unit prices, thereby improving their business performance. Compared to commodity companies, many companies will have relatively low costs associated with direct environmental measures. In addition, as many of these economically rational companies are downstream in the supply chain, they are expected to play a role in requiring their suppliers to adopt sustainability measures as a customer.

Therefore, in the current context where political leadership is unlikely to be forthcoming, the importance of a bottom-up approach, where downstream high value-added companies take the lead in promoting sustainability and influencing other companies, is expected to increase. In order to make the economy as a whole more long-term oriented, it will be important for investors to be aware of this point in their engagement.

At Cadira Capital Management, we aim to improve the quality of our investment decisions by incorporating the above-mentioned economic rationale of sustainability into our investment hypothesis building. In addition, our policy is to promote both impact generation and corporate value creation by including the link between sustainability and value added in the dialogue agenda with companies.