As an industry we love acronyms. One that is beginning to be embraced by a broader number of investors is ESG – Environmental, Social, Governance. Although ESG is receiving growing attention from the media and investors alike in recent months, it is not an entirely new approach. In fact, some of the first ESG investors were the Quakers 200 years ago when they forbid investments in slavery and war.
What is ESG Investing?
ESG refers to the three central factors in measuring the sustainability and ethical impact of an investment in a company or business.
ESG is an umbrella term for a certain approach to investing, however, there are a number of different forms of ESG that are important to delineate. To start, “Impact Investing” is a process that uses thematic screening to look for a specific outcome. For example it might be a fund that raises money that will provide access to education, energy, water or affordable housing. “Socially Responsible Investing” (SRI), on the other hand, is a screening process that will exclude certain types of companies or industries like tobacco, alcohol, or fossil fuels. Finally, “ESG Integration” is a process to gain a deep understanding of a company, its long-term decision making, and how it will survive in the regions and industries it lives in. Armed with this understanding, a Portfolio Manager using, ESG Integration, can make a decision whether to add the company to their portfolio or not.
The following article by RBC Global Asset Management provides a more detailed look at ESG Integration: https://www.rbcgam.com/en/ca/article/the-future-of-esg-integration/detail/
So why is ESG becoming more relevant now?
One reason ESG might becoming more relevant now could be a result of high profile impact investors, like Al Gore and Bill Gates, entering the psyche of investors. People are becoming more concerned about environmental sustainability and keeping pace with societal changes.
What is interesting is that ESG means different things depending on the region or industry that a company is in. What matters most is not universal around the world. For example, the E has greater acceptance, awareness and commitment in Europe. This is not the case in the US, where the E causes a lot of friction and is highly politicized, while the S fosters cohesion and support.
As a Portfolio Manager, we need to communicate that this topic is important to us; that Environmental, Social, And Governance causes are necessary to consider. However, the term ESG is often taken up by funds as a theme to market themselves to socially conscious investors. In my experience, these types of thematic funds have the right idea but end up with poor execution and performance. In contrast, ESG Integration is part of a process of investing where a deep understanding of companies can enhance the construction of a portfolio and its performance.
Portfolio Managers, including myself, are excited that ESG concerns are becoming more ingrained in investment decision making. It is an important step towards aligning good corporate behavior and investor values that in the long term will reward everyone.