How do ESG factors fit in a Portfolio?

July 12, 2019 | Jonathan Yung


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Incorporating Environmental, Social & Governance Factors in Investing

As a new decade approaches, investors are increasingly considering the ‘sustainability’ of their investments. Sustainability consists of three factors: Environmental, Social and Governance (ESG). These factors are combined with financial factors to determine whether a corporation can generate a long term sustainably positive outcome. This trend is particularly visible among Millennials, who are increasingly interested in aligning their investments with their personal values.  Approximately 82% of millennials surveyed by the Responsible Investment Association of Canada (RIA) plan to implement ESG factors to their investment decisions over the next five years.

How are ESG factors implemented in investment decisions?

Environmental: Environment factors consider the impact of a company’s activities on the climate, including greenhouse gas emissions and the risks and opportunities presented by climate change, energy efficiency, pollution, water and waste management, site rehabilitation, biodiversity, and habitat protection.

Social: Social factors considers human rights, community consent/impact, respect for indigenous peoples, employee relations and working conditions, discrimination, child & forced labour, health & safety, and consumer relations.

Governance: Governance factors consider the alignment of interests between executives and shareholders, executive compensation, board independence and composition, board accountability, shareholder rights, transparency/disclosure, anti-corruption measures, financial policies, and the protection of private property rights.

Studies have shown that incorporating these considerations into one’s investment process does not come at the expense of performance but rather, returns are improved. Companies that rank well in each ESG factor infers a stock that has less risk in attracting corporate scandals, regulatory penalties, and damaging publicity. Moreover, shareholders should benefit from companies integrating ESG into the company’s strategy as it ultimately leads to a lower cost of capital, better operational performance, and better long term share price performance. Below you can see an example of how strong or weak ESG business practices can affect share prices.

These considerations and strategies are being implemented by larger asset management firms. In an independent survey led by RBC Global Asset Management of 542 global institutional asset owners and consultants, 72% of respondents use ESG principles in their investment process. Some portfolio managers meet personally with the companies in which they invest on an ongoing basis and discuss risks and opportunities relating to ESG factors and use proxy voting as a tool to cast their support for ESG related issues.

Although ESG factors may already be inherently considered in an investment product, it may not always be practiced in a consistent and disciplined manner. To ensure the adoption of ESG factors in an investment product, investors can look towards certain managed mutual funds or ETFs that make ESG investing their core mandate and process. Like any managed product, due diligence must be taken to ensure you understand their experience in ESG investing and the method of how they score each ESG factor by company and sector. Interested clients should speak to their advisor to learn how to effectively implement ESG factors into their portfolio.