ESG Is More Than Just 3 Letters

John Tennaro, CIMA®
September 24, 2019

Interested in both doing good and investing? We explore growing ESG trends, its lack of standardized methods of measurement, human intentionality, and tips on how to identify genuine ESG contenders.
“Ultimately, human intentionality is the most powerful evolutionary force on this planet”    -George B Leonard

It was not long ago that much of the investment marketplace was reluctant to embrace sustainable and responsible investing. The notion that environmental, social and governance (“ESG”) factors could have a meaningful, financial impact was often discarded and cast to the shadows. However, the tides have shifted and now ESG has a captive audience. More investors than ever are sidestepping out-of-date stereotypes and myths about sustainable and responsible investing, and are now ready to act.

This inevitably leads us to the landscape of “ESG” investment options. A space once dominated by only a handful of proprietors, has recently seen a surge in popularity. This has led to a frenzy of headlines and activity resembling the Wild West or dot-com era of the late 90’s. For every genuine and authentic product, there are a multitude of others using short-cuts and imitations to earn a seat at the ESG table. 

According to Morningstar, over 100 conventional (non-ESG) funds have added ESG language to their prospectuses through the first half of 2019. Others have just changed the name of their strategy to include such keywords as “ESG” “sustainable” or “impact”.  Alongside of rebranding or renaming products,  there are also new strategies using a ‘copy and paste’ approach that relies on clever marketing to compensate for its lack of ingenuity.

The recent ESG trend has merged with an even greater trend: the rise of exchanged-traded funds (ETF’s). The result has been a significant increase in so-called ESG ETF’s. Many of these funds are created by replicating an index that has been primarily created by a computer-generated scoring system. In many instances, this has left investors surprised and confused with what they find in their portfolios.  Imagine being an investor who cares about the environment or corporate governance only to see that your portfolio includes companies like ExxonMobil or Equifax, as some ESG ETF’s do.  

Additionally, there is no standardization to ranking companies on a ESG scale, and therefore, these ETF’s can contradict each other. One ETF’s might score a company positively and load up on it, while another ETF could find it undesirable and avoid it altogether. While a difference of opinion is expected, to better understand why would require a potentially awkward conversation with a computer.

This isn’t to suggest that all ETF’s are fundamentally inadequate for environmentally- or socially-conscious investors. For example, clean energy remains a rather niche market, one that is still emerging and evolving. And consequently, the list of investment options remains relatively limited. Therefore, clients might find pursuing a pure play ETF as the most suitable choice. Regardless of the size or scope of an industry, it is important to know how your capital is being allocated and the process behind those decisions.

Unfortunately for investors, this “greenwashing” trend—of providing misleading ESG claims to investors in order to capture ESG assets—is prevalent. With this in mind, you should understand all of the ESG features of a firm and strategy before making an investment.

The foundation of sustainable and responsible investing is intentionality—to have purpose. Any investment manager should be able to discuss a legitimate approach to why he or she selected the assets. Without this intent, there is no certainty that your portfolio will continue to include ESG assets over time. For example, a conventional strategy may look environmentally friendly today because it lacks exposure to oil and gas companies. However, does this indicate an ESG strategy or could it be because the energy sector has struggled and was not included in the portfolio. And, if the sector recovers, will the portfolio then be heavily allocated to fossil fuels? It seems safe to assume investors would prefer their investment managers use a disciplined approach to making decisions instead of blindly throwing darts at the wall.

The good news is that there are methods in which investors can use to identify genuine ESG contenders and to avoid pretenders. 

How to identify genuine ESG investment options

  1. Make sure that you understand and can articulate your own objectives and preferences. An essential part of implementing a sustainable and responsible approach is identifying what matters most to you in order to find a suitable investment to meet your requirements.
  2. Find out how ESG plays a role with the culture and philosophy of the sponsoring firm. These questions, and many more, can improve investors’ chances of finding truth and conviction in what they’re being told (or sold). Included below are a few examples of meaningful questions to be answered:
     
    • How long has the manager/firm been actively using ESG criteria?
    • How many strategies include ESG factors and how much of the manager’s/firm’s assets include ESG factors?
    • How does the manager/firm incorporate ESG factors into traditional financial analysis?
    • How do ESG factors play a part in the decision-making for specific assets in the portfolio?
  3. While stars, globes and other scoring systems may seem helpful, don’t let them determine your selections as they will rarely tell you everything you need to know.  

 

As sustainable and responsible investing is a rapidly evolving space with many new concepts and moving parts, it can seem overwhelming at times.  At CIBC Private Wealth Management, we are happy to assist you with understanding more about your ESG investing goals and options backed by our thorough due diligence and expertise. We believe that investors interested in ESG should demand a portfolio created by intention not chance.

John Tennaro is a senior vice president and senior investment analyst in CIBC Private Wealth Management’s Washington, DC office with more than 20 years of industry experience. John oversees CIBC’s efforts in Sustainable and Responsible investing.  John is also responsible for investment manager due diligence and selection within the Multi-Manager Investment Program’s traditional investments team.