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Are you a buy-and-hold investor? Buying and holding stocks long term is a strategy that can help you maintain a more stable portfolio while weathering short term fluctuations. Another strategy is to incorporate sustainable principles into your investing. This approach involves taking environmental, social, and governance (ESG) considerations into portfolios. You can integrate ESG considerations in your investments while also attaining market-like returns if portfolios are appropriately constructed.
Demystifying the E,S and G
ESG considerations are applied by socially conscious investors to assess the social impact of a public company’s operations.
The number of publicly listed companies reporting ESG data has grown exponentially in the last two decades. While only 12% of the largest 100 companies in each of 49 countries (4,900 companies) issued sustainability reports in 1993, that number grew to 75% in 2017. More companies are committing to the ESG way of doing business.
The “E” assesses how a company performs as a steward of all things environmental. Picture trees, butterflies, and waterfalls. Focusing on the environmental factor involves evaluating how a company uses its resources and sets policies to minimize any harm it has on its surrounding environment. With these considerations, these “tree huggers” actively work to protect the environment. Environmental criteria may include a company’s energy use, waste, pollution, natural resource conservation, and treatment of animals. These questions might be helpful:
- Does the company manage its waste disposal or recycling protocol well?
- How much carbon does the company emit?
- Is it a larger polluter?
- How efficient is the company’s water and power usage?
A company is likely to receive a higher “E” score if it has comprehensive environmental policies, practices and procedures in place. If you remember the three-eyed fish from the Simpsons, you probably know that the Springfield Nuclear Power Plant would not get a very good score.
The “S” is the social factor, which accounts for how companies manage their relationships with all of their stakeholders. These stakeholders could include employees, suppliers, customers, shareholders, and the communities they operate in. Some valuable questions could be:
- Are women in senior management roles either in the C-suite or on the Board?
- Have the company’s actions ever infringed upon any Human Rights violations?
- Does it have similar values to the suppliers it works with?
- Does the company support equal pay for all genders?
- Is the company a safe place to work, and does it treat its employees fairly?
- Does the company donate a percentage of its profits to the local community or encourage employees to perform volunteer work there?
The “G” evaluates governance of a company’s corporate policies and procedures. As anyone who’s worked for a company could tell you, a company’s head honchos are crucial to how it’s run.
- Is there diversity on the Board, or does it look like Mount Rushmore?
- Are C-Suite compensation policies fair and transparent?
- How strong is communication and relations between the management team and the employees?
- Does the company conduct and present itself in an ethical fashion?
- Are accounting practices consistent and conservative?
- Does the company have any Scarlet Letters or reputational baggage?
Unlike traditional financial analysis, quantifying the exact financial benefits of ESG scores is not so simple. That’s the beauty of nuance, right? Several studies, however, have shown that companies with highly rated ESG practices carry less risk and can generate better performance than peer companies with less of a focus on ESG factors.
Sustainable investing and impact investing are essential to a lot of people. Many believe that incorporating these additional factors into the analysis will yield concessionary returns. That is not necessarily the case, though. Some investments could be, but factoring in ESG could actually prove to be a value-driver. Many studies show that ESG integration can lead to equity outperformance over time. As per HBS Professors Robert Eccles and George Serafeim “Material ESG… strategically focus[es] on the environmental, social, and governance (ESG) issues that are the most relevant—or “material”—to shareholder value, firms can simultaneously boost both financial and ESG performance.”
On the contrary, ESG considerations could in fact serve as a risk buffer against economic downturns. ESG measurement could just be a way of measuring how efficient a company is with its resources. Companies with strong ESG scores may be more efficient and active in managing their resources and resilient to climate risks.
Still a learning process
For now, the data isn’t great – many sources cover different timeframes and portray the various impact categories in different terms. But it is improving every year. Initiatives, including the GIIN’s IRIS+ metrics, SASB materiality map, and Impact Management Project framework, have been successful steps forward.
Right now, we still haven’t reached impact harmonization for a common language of what is meant by sustainable cities, clean water, or health. Therefore, transparency is needed in the products that you are investing in. You may find it valuable that they match your values and align with what you think you are supporting with your investments. Follow your head and your heart.
Not only do you need transparent products but also ESG advisors and specialists who can go beyond the data to parse out what the individual score components in the ESG data actually mean.
Living your values in every way, as best as you can, often delivers a positive emotional return. Any realignment of your portfolio can offer more value than you think. You can have a sustainable portfolio that doesn’t compromise your long term return goals but actually enhances your risk-adjusted returns in the long run.
We believe it is possible to create sustainable portfolios that do not compromise return goals — and could potentially enhance risk-adjusted returns in the long run.