Our team recently participated in two ESG investor events, Baird’s Investor Perspective on the Evolving ESG Landscape webcast and Q4’s ESG Panel, both in June of 2020. The following are interesting takeaways from both:

ESG’s influence on investment management is rapidly increasing:

  • In 1Q20, ESG funds experienced record inflows, even amidst the COVID-19-induced market volatility.
  • Most recent global estimates say sustainable investments account for more than $30 trillion in AUM.
  • In the US alone, 1 out of every 4 dollars of professionally managed assets are invested under an ESG mandate; a trend that shows no signs of slowing.

How do investors engage with management on ESG?

  • Carve out 6 E & S themes:
    • E: 1) Greenhouse gas emissions, 2) Natural resource use, and 3) Climate change vulnerability
    • S: 1) Human capital, 2) Supply-chain management, and 3) Access and affordability
  • Tap into insights of company’s largest internal growth engine: their culture.
  • Encourage companies to put out employee and/or stakeholders surveys to self-identify areas of opportunity for further disclosure, increase employee alignment over the long term, and improve management receptiveness of the company.
  • This is a great way for small- and mid-cap companies to identify their “end goal” for their sustainability program and develop ESG disclosures aligned with SASB.

Why are firms caring more about ESG landscape?

  • Firm’s customers are asking for it in the RFP/RFQ process. Being a PRI signatory is not good enough anymore.
  • Growing body of research that shows some aspects of ESG result in higher long-term returns.

Should companies adopt an ESG framework?

  • SASB is preferred as it places more focus on material risks; not explicitly concerned with risks such as deforestation.
    • SASB is continually adapting, learning, and improving their framework.
    • Function over form: More standard collection of metrics.
  • At the very least, companies should be aware of the predominant reporting frameworks, and what suits their company best.
  • For investors, the most important aspect is that the management teams convince them that they are thinking about sustainability and are putting forth effort into improving their ESG program. 

How can issuers improve their overall approach to ESG and investor engagement?

  • Run a long-term stakeholder analysis that identifies key non-financial risks.
  • Compensate and align executives to make progress on material ESG metrics.
  • Align company philosophy and culture (employee survey) toward ESG.
  • Prioritize the company’s stakeholders over its shareholders.

Institutional Mindsets Behind ESG Integration

Alliance Bernstein

  • Believes the old perception of ESG was that you had to sacrifice alpha to get it. The new perception is that ESG is actually giving PM’s additional tools in their arsenal to be able to analyze companies.        
  • ESG ratings are a great starting point, but they boil many factors down to a single letter grade, are backward looking, mechanical, and focused on only what can be measured (disclosure) versus what should be measured (action). Engagement with management teams around material issues is more important.

Barrow Hanley, Mewhinney & Strauss

  • Emphasizes the importance of issuer engagement and improving the communication channel as it relates to ESG disclosure.
  • ESG provides opportunities for re-rating and increased valuation. Historically, ESG-oriented companies have been more defensive.

Impax Management

  • Impax invests in companies that offer solutions to environmental and resource problems. ESG is integrated into Impax’s investment process in 3 ways:
  • Which markets in the future will be better positioned in the transition into a more sustainable economy?
  • How are individual companies within those markets managing their risk? Within risk, how are they thinking about E, S, and G issues?
  • Engage with companies and understand their particular challenges and focuses, and ultimately provide advice into the future.

Pictet Water, Pictet Asset Management

  • ESG is both a source of opportunity in defining its investment universe, and an important tool for risk management. Companies that score better within ESG are given a lower cost of capital in their valuation models.

T Rowe Price

  • Views ESG from a materiality lens as both a risk and an opportunity for companies.
  • Admits, initially, portfolio managers were good about incorporating E and S when they were obvious to the investment case, but were not proactive in looking for potential issues. That has changed significantly.
  • Recommends using SASB and TCFD because they focus on financial materiality. Collects ESG data quantitatively to be able to measure against benchmarks effectively, so it is important how companies display this data, to ensure it is digested accurately.

Wellington Management

  • Wellington likes to identify where ESG poses a risk and invest where ESG is a return.
  • For example, companies that are de-carbonizing or developing sustainable infrastructure create revenue opportunities for a select number of companies.
  • Corporate governance and corporate stewardship are significant long-term drivers of financial performance and stakeholder experiences.

In today’s advancing ESG disclosure environment, investors all agree that disclosing sound sustainability principles and metrics in a format easily analyzed by investors and their AI programs alike is becoming critical to the risk assessment process for public companies.