Including ESG (environmental, social, and governance) factors into the investment process not only enhances returns over the long term, it also allows you to align your values and priorities with your investments. While historically, socially responsible investing meant the avoidance of “sin” stocks (alcohol, firearms, pornography), ESG investing allows you to focus on what you want to include – companies with good environmental practices, strong workplaces, and high levels of transparency and incentives. Additionally, ESG investing takes into account a broader base of stakeholders including the workers of a company’s supply chain and the customer base of a company. ESG investing shouldn’t be viewed as optional or alternative, but rather a relevant and necessary complement to traditional investing.
Companies that have a sustainable, long term oriented culture tend to deliver better long term risk adjusted financial returns. While there are numerous studies that have shown this over time, the most relevant is simple common sense – companies that treat their employees well have lower turnover and therefore more productive staff; companies that have good checks and balances in their governance structure will likely steer clear of unethical business practices. A recent Banc of America Merrill Lynch study found higher ESG companies exhibited lower earnings volatility and higher return on equity; the same study found that a portfolio selected in 2008 of companies with ESG ratings in the top half of the universe would have avoided 15 of the 17 bankruptcies that have occurred in the universe since then.
The historical challenge with incorporating ESG analysis into the investment process centered around the lack of data. In the past 5 years there has been significant pressure exerted by the investment community on companies to supply more and more data around environmental, social, and governance factors. There is now a Sustainable Accounting Standards Board that is working to standardize and stipulate data requirements for companies. The vast majority of the Fortune 1000 now have corporate sustainability heads; more companies are recognizing that they are powerful global institutions that can have a positive impact on solving some of the world’s biggest problems, and that their customers and even their employees increasingly expect them to do so. There are a number of companies that specialize in analysis of ESG data specifically for public companies, applying scoring methodology to make comparisons across companies and industries relevant. In Europe it is standard investment practice to include ESG factors in investing; pressure is mounting in the US for similar practices to be incorporated.
There are many different approaches to ESG investing. Utilizing the scoring methodologies created by the firms that specialize in ESG analysis, some investors simply screen out the lowest scoring companies. Others screen out entire sectors, energy being the most common; or avoid certain types of companies, those involved in firearms being a common theme currently. It is important to understand how your advisor incorporates ESG factors and what access to data they have. The industry is not yet advanced enough to only rely on company websites and company publicly disclosed data. The research firms who specialize in ESG analysis take their analysis well beyond this, engaging with the sustainability departments of companies and asking the relevant questions. Similarly, the data and disclosure is not yet uniform enough whereby screening out companies based on certain scores can be relied upon as an efficient approach. At Prio, we believe that judgement is critical, and utilizing the research provided by the specialists, coupled with further analysis and a focus on what matters most to each client (ie. Some clients care most about employee diversity; others are more concerned with the environment) is the best approach to gaining the maximum benefit from ESG analysis.
Our approach at Prio is to incorporate ESG analysis into every investment decision. We utilize the ESG data provided by Sustainalytics along with company disclosed financial information as an integral part of our investment process. We believe that the less quantifiable factors of how a company does business (along the lines of ESG) are equally relevant in the long term performance of a company. At Prio we believe our clients values and beliefs can and should be incorporated into an investment portfolio. ESG factors allow this in an enhanced and integrated way.