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10 things to know about ESG investing

John Tennaro, CIMA®, CSRIC™

December 13, 2021

By Head of ESG and Impact Investing Solutions John Tennaro, CIMA®, CSRIC™

Environmental, social and governance (ESG) investing is a broad term that spans many aspects of business, both very specific and all-encompassing. While ESG has a standard definition, how it is interpreted and applied varies from source to source. Therefore, it is essential to understand what a person or company is referring to when they make an ESG claim or reference.

When it comes to assessing ESG statements and investment opportunities, we recommend investors not only ask for specific details, but have a baseline understanding of the nuances of this space. Below we highlight what we believe are 10 features of ESG that are often overlooked, underappreciated or misconstrued.

10 features of ESG that are often overlooked, underappreciated or misconstrued

1. ESG investing is done in addition to traditional, fundamental analysis and is designed to be used as a part of an overall investment evaluation and analysis.
Like well-known financial metrics such as revenue, earnings growth, profitability, free cash flow generation or valuation, ESG factors can help inform investors about supplementary aspects of a business/industry to help determine investment suitability.

2. Avoid considering ESG as being wholly responsible for overall performance.
To expand upon the first point, it’s impractical to attempt to strip out ESG factors when determining the positive or negative contribution to performance given the fact that most strategies are likely incorporating many non-ESG factors as previously described.

3. Often the perception is that ESG factors are exclusionary or restrictive forces that will either detract from performance or impede potential upside.
However, we associate ESG with value (i.e., company worth) just as much as values (i.e., personal beliefs or ideals).

4. While ESG factors by themselves are relatively objective, how they are used can be very subjective.
In other words, one investor’s view of a company through an ESG lens can vary dramatically from another’s. There are no official or regulatory standards to determine a “good ESG company” vs. a “bad ESG company.” Indeed, most are neither, and labeling them as one or the other misses the premise behind ESG investing.

5. ESG is not one-size-fits-all—materiality matters. As is true with traditional, fundamental analysis, no investment will be perfect on all ESG factors.
While evaluating all issues is fine, the emphasis should be primarily on those issues that are financially material to a company. Certain ESG factors are more impactful than others to a company. For example, fuel efficiency has a bigger impact on the bottom line of an airline company than it does for a bank.

6. ESG can help unveil and mitigate risks and issues that traditional analysis often doesn’t uncover or consider, which can allow for further preservation and protection of investor assets.

7. In turn, ESG factor analysis can also help identify innovations and opportunities.
Some ESG strategies look to invest in companies that are best positioned to benefit from structural shifts in the way companies and consumers do business.

8. Instead of trying to decipher all the different ESG labels and terms, we believe it is more useful to focus on and understand the four primary ESG investment approaches: avoid, incorporate, emphasize and engage.

Approach

"Also known as"

Description

Avoid

Exclusionary/negative screening, socially responsible investing

Avoiding companies, industries or sectors that do not align with your goals and values or those that disregard widely-accepted ESG norms

Incorporate

ESG integration, risk-return ESG, positive screening/best-in-class

Intentionally incorporates ESG factors into investment decisions to help unveil company-or-industry related risks/issues while also helping identify potential opportunities

Emphasize

Impact investing, thematic investing

Thematic pursues long-term themes tied to sustainability and ESG while impact targets investments with the intention of achieving specific social and/or environmental impact that can be tracked and reported over time

Engage

Shareholder/stakeholder advocacy, proxy voting

Engaging with company management to address issues stemming around ESG factors or being actively involved with voting proposals designed to influence corporate behavior on ESG issues


9. ESG investing shares many attributes with actively managed investing.
Like active management, ESG investing relies on analytical research, personal judgment and a consideration of a wide range of quantitative and qualitative factors that can lead to higher conviction in future projections.

10. This space provides an opportunity to connect generations in a common dialogue.
Investments and wealth can prove to be a challenging discussion between generations, and ESG-related topics, such as philanthropic interests and legacy endeavors, can serve as a conversation-starter and middle ground despite age.

Research and investment case support

All of the above considerations aside, the big question that remains in this space is whether integrating ESG factor analysis into the investment process has had an overall positive impact on the world and/or an investor’s portfolio. Much of this research relies on data and information that, unfortunately, cannot account for the subjectivity and opinion that inevitably exists with ESG. Therefore, the outcomes from related studies are best interpreted as supportive of the positive investment impact argument, rather than definitive. A few notable examples include:

  • University of Hamburg and Deutsche Asset Management conducted a meta-study that established a positive correlation between ESG strategies and strong financial performance. The study examined ESG and corporate financial performance across more than 2,000 academic studies since 1970.
  • In a 2015 report, Oxford University and Arabesque Asset Management found that in 88% of the research conducted on over 200 sources regarding ESG performance that "robust sustainability practices demonstrate better operational performance, which ultimately translates into cash flows."
    • Additionally, 80% of the studies reviewed show "prudent sustainability practices have a positive influence on investment performance."
  • According to the Corporate Investment in ESG Practices report published by The Conference Board Inc., companies that spend money to continuously improve their ESG performance may also see a return on their investment through higher market and accounting performance, as well as a stronger business reputation and improved stakeholder relations, which can, in turn, lead to more product innovation and increased revenues.

John Tennaro, CIMA®, CSRIC is the Head of ESG & Impact Investing Solutions, and is responsible for overseeing all aspects of our firm’s approach to ESG & Impact Investing.