Using Environmental, Social, and Governance data provides additional insight for making educated investment decisions.
In a lot of ways, investing is an art and a skill: An experienced investor evaluates lots of different kinds of information about a company and its industry (a skill) and uses that to paint a nuanced picture of that company’s fundamentals (an art). Any information that can clue an investor into the company’s competitiveness in its field, its long-term prospects, the way it does business, and who it does and doesn’t do business with — all of that can have great value in composing that nuanced picture in a way that reflects the reality of the situation. That’s what ESG investing is.
There are some misconceptions about ESG investing. The initials stand for “Environmental, Social, and Governance,” which can set some investors on edge. But this isn’t a code for do-gooding with your money at your expense. “Socially responsible investing” is a different thing. Instead, ESG investing means acting on more information than just the mandatory metrics on balance sheets.
Research has shown that following ESG metrics and investing in companies who keep an eye on sustainability may offer lower market risk than traditional investing. For instance, NYU’s Stern Center for Sustainable Business looked at more than 1,000 research papers from 2015 to 2020. Their meta-study found that companies that operated with an eye on ESG consistently showed positive financial performance, and ESG investment returns showed the same performance as traditional investment.
Morningstar has ranked asset managers based on ESG factors, because these factors give you broader information about how sustainable a company is. Evaluating the impact a company has on the community they operate in, how they manage environmental and social factors, helps to gain a clearer picture of potential risks, and potential long-term profits.
Weighing ESG factors also shows an engagement with the complexity of real life. For the most part, these measures can’t be applied in a one-size-fits-all framework. For instance, employee turnover (a social and governance issue) might be less significant in a company like a college-town restaurant chain that relies on seasonal, entry-level workers than it is for a biotech firm that relies on proprietary research and long-term, specialized industrial knowledge. ESG factors can also be hard to assign a direct monetary value. Is the fossil-fuel use of a diesel-operated machine shop more financially impactful than the data-security policies of an online subscription service? Well, that would depend on a large number of factors, from subscriber base to the price of fuel. But an ESG analysis will take these things, which have direct bearing on a company’s ability to thrive, into account.
Note also that the “E” is not more significant than the “S” or the “G” in those examples. Environmental impact can take in anything from water rights to greenhouse gas production to regulatory risks to the way a company handles waste management. Social factors can include things as varied as cybersecurity measures, worker satisfaction, gender diversity, and product quality. Governance takes in the way a company conducts itself, which might include everything from the structure of the board to political contributions to public relations on social media to the salary difference between the CEO and the lowest-paid worker. All three categories speak to what a sports fan might call “intangibles” — they can’t be easily measured, the way a quarterback’s size, weight, age, and speed can. But each of the categories interact in significant ways, and each category carries its own weight in determining a company’s long-term viability.
In short, ESG is not a way to exclude some companies or include others. Instead, it’s a framework for increasing the depth of knowledge for any company. As always, if you have questions about ESG analysis or any other research methods, please ask an advisor. They’re happy to share.
https://www.calvert.com/media/public/35823.pdf- NYU Stern research (citing NYU Stern Center for Sustainable Business (in partnership with Rockefeller Asset Management). "ESG and Financial Performance: Uncovering the Relationship by Aggregating Evidence from 1,000 Plus Studies Published between 2015 – 2020," Tensie Whelan, Ulrich Atz, Tracy Van Holt and Casey Clark, February 10, 2021.)
https://www.calvert.com/media/public/40053.pdf - less “E” more “S” and “G”