ESG Investing Comes in More Flavors than Chocolate and Vanilla

Written By George Tripkos, Senior Consultant

October 27, 2021

There are Many Options in the Freezer

Unlike the ice cream waiting in my freezer, ESG investing is here, and it is here to stay. But like the ice cream, ESG investing comes in several flavors. According to SASB, there are five key ESG investment strategies, which more than three-quarters of institutional investors are keen to employ. And, they’re clearly hard to resist, as global markets ended 2020 with $37.8 trillion in ESG assets under management, with projections to reach $53 trillion by 2025. Investment clients are asking for more ESG investing, and portfolio managers are serving it up.

Investors Aren’t Putting their Flavors on the Side of a Truck

The options for ESG investors are not always black and white or chocolate and vanilla, though. ESG investing often manifests through strategies and selection processes that are not really externally advertised by portfolio managers. But just because you don’t see it doesn’t mean it’s not there. This means that companies have a bit of investigative work to do to fully understand how investors are making decisions. And knowing the ways ESG investing actualizes in products can help IROs better interpret how a portfolio manager is integrating ESG, leading to more fruitful conversations between the two sides.

Anticipate the Tastes

Since no one likes biting into an ice cream cone of an unexpected flavor, it’s critical that we first understand the investment strategies that portfolio managers are employing. This will help us avoid being caught by surprise and allow us to better tailor our conversations accordingly. It can also help us avoid brain freeze when the so-called “perfect” investor doesn’t buy in due to ESG screening limitations. Here’s a primer on each strategy to help you better pinpoint a portfolio manager’s style.

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1) Exclusionary Screening

  • The simplest of the strategies, exclusionary screening, or sometimes called negative screening, omits companies from the investable universe that do not meet certain standards or moral codes. Whether you are targeting ESG capital or not, you can be included in these types of funds for simply having the proper business model or divesting from unethical practices. Alternatively, you can be excluded from this universe simply based on your industry.
  • Case In Point: $XVV – Blackrock, one of the industry’s leading the way in ESG investing, offers an S&P 500 index fund that screens out companies with businesses that involve controversial weapons, tobacco, oil sands, thermal coal, and fossil fuel energy.

2) Positive Screening

  • Rather than screening companies out, this strategy takes a step further with selective inclusion of companies with leading ESG ratings or ESG rating growth. This method highlights the importance of proper disclosure and strong ESG programs to receive good ratings and access to this capital. Positive screening is the most widely used ESG investing strategy.
  • Case In Point: $SUSL – Another Blackrock ETF, the fund goes beyond just screening out non-ESG friendly companies and gives direct exposure to the top-rated companies in each sector with regards to ESG scores, provided by organizations like MSCI, Sustainalytics, ISS, S&P, Bloomberg, and others.

3) ESG Integration

  • Second only to positive screening in adoption, ESG integration is set to become the standard in the industry. This strategy incorporates ESG data alongside traditional financial analysis throughout the investment selection process, and often involves proprietary research in combination with ratings. When engaging ESG integrated firms, it is important to ask the right questions and determine what factors are most important to the portfolio manager.
  • Case In Point: $PARWX – Parnassus may appear to offer your run-of-the-mill funds, but the firm, as a whole, incorporates ESG ratings and research to find companies with sustainable competitive advantages to drive outperformance.

4) Impact Investing

  • You may see the term “impact” thrown around a lot when it comes to ESG investing, but it should be reserved for only the most ESG-aligned of funds. These funds invest in companies that generate a positive and measurable ESG impact. It is the double chocolate chip of ESG investing, as companies that fall under the impact investing scope are typically the broad market leaders of ESG. The critical differentiator here is that other strategies typically assess the inputs for a business, such as resources or ESG policy, but impact investing looks at the outputs—or rather the positive, measurable effect the business model has created for society.
  • Cases In Point: $HGXIX – This Hartford mutual fund is a broad-based impact fund that includes companies with operations that promote areas like sustainable agriculture, health, sanitation, and affordable housing.
  • $AQWA – Many impact investments are more specific to address one particular issue. For example, this Global X ETF invests in companies across the globe leading the way on clean water to affect positive social change and financial returns.

5) Active Ownership

  • This strategy is more of the “sprinkles on top”, as it does not pertain to the investment selection process but, rather, how a firm engages its holding companies. So, in other words, it can be applied to any portfolio. Active owners engage leadership and exert voting rights to influence the company to change behaviors or tactics – in this case to promote ESG efforts.
  • Active ownership is more common in index strategies, particularly those with large share concentrations that have the resources and ownership stake to exert influence. Familiarizing yourself with a firm’s activism history and values are critical to fostering productive discussions with investors.

Understanding the range of strategies investors use can give IROs and management teams an edge in accessing ESG capital. Depending on your industry, your ESG performance and your level of ESG-related disclosure will vary, and so will the ESG investors you target and your approach. Clermont Partners can help you craft disclosures that fit your business, drawing on our years of experience and knowledge of disclosure standards. In addition, we can help you find the right funds for your company and communicate in the most effective way through our proprietary targeting analysis. Our method takes both a quantitative approach that analyzes ESG ratings and portfolio metrics as well as a qualitative approach in aligning fund values with your company.

If you need help targeting the right investors or developing your ESG-related messages, contact us. We’ll be happy to chat over Rocky Road.

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