When the term “ESG” was coined back in 20041, the goal was to focus “on issues which have or could have a material impact on investment value” over “longer time-horizons (10 years and beyond) and intangible aspects impacting company value.”1 In contrast, SRI (Socially Responsible Investing), was mostly synonymous with values-driven exclusionary investing styles. In the years that followed, the distinction between values and value has often been upheld, but in practice, the boundaries are more ambiguous, especially as data has grown in depth and breadth, and as these investing styles have become more popular.
We see ESG as the underlying dataset that can be leveraged to make a wide range of investment decisions, depending on the investment philosophy or focus of a portfolio manager or asset owner. For example, ESG data can be used to create an S&P 500 index-tracking strategy that has, say, a lower carbon footprint and/or better board diversity than the underlying benchmark. Or ESG data could be used to construct a thematic strategy focused on water investing that makes active bets on which companies are creating the best or most scalable technological solutions to water constraints. Or, it could be used, as with SRI-styles, to remove an entire sector or group of companies based on a personal preference, which might be religious, political, or otherwise determined.
Over the years, despite frequent calls to define terms, sustainable investing definitions arguably have become murkier. Many platforms that provide custom indexing and other personalized portfolio construction use “ESG” and “values” interchangeably, which can confuse both advisors and investors. Widely held societal values are important. They are part of a company’s operating context and can become financially material. Climate change and social justice are two topics that have gained increasing prominence in recent years, but other values-based topics may be more niche and less likely to impact company financials and valuations.
ESG is now part of the mainstream and product options are growing by the day. Some are truly authentic, created by firms that have an ethos aligned to their marketing messaging. Others are, put simply, a cynical asset gathering tool. It’s therefore important for an investor to know what they are really getting when they put their money into an “ESG strategy.”
Some tools and strategies take a more passive investment approach but allow investors the flexibility to exclude and include certain companies based on controversy data, industry-level data, or other variables. The underlying data enabling these decisions may be highly sophisticated or more superficial. Understanding what data is used, how it is collected, and whether it’s forward or backward-looking, is therefore key to advisor-investor research.
As many ESG topics are complex and often interlaced with other topics, deeper analyses may be needed to make optimal long-term investment decisions. Take fossil-fuel divestment, for example: some investors believe it’s imperative to exclude the entire oil and gas sector, as well as other companies that are high emitters, such as cement and aluminum companies. However, some managers believe that a select group of these companies have the ambition (or potential) and the balance sheets, to be a significant part of the low carbon transition. Conversely, some consumer goods companies perform very well on social issues and may therefore be included in a portfolio of companies that also have high “S” scores. But, when considering plastic, water usage, and questionable nutritional content, an entity’s impact on the world may look much less positive. Given the breadth and depth of data available, it’s incredibly challenging for any individual to be able to sufficiently consume and synthesize the entire picture and then make an investment decision.
Our investment philosophy, which is centered on climate change, amongst other ESG topics, looks at climate risk from a physical and transition perspective and incorporates adaptation opportunities as well as climate mitigation. The inherent uncertainties, trade-offs, and challenges within this space necessitate working with active managers who understand the ever-evolving climate datasets available and have teams of people continually updating their analyses. Our ESG process, therefore, is mostly diligence of the managers themselves to help ensure that their stated philosophy aligns with their actual portfolio decisions.
However, what’s exciting for advisors and investors who work with us is that we’ve made it possible to marry the sophisticated work undertaken by our active managers and allow individuals to reflect their personal values and preferences. Our Unified Managed Account (UMA) models are powered by Natixis, which integrates a range of MSCI data points, allowing an individual to also determine whether they want to exclude certain companies from the overall portfolio.