As socially progressive investors, we perform our own due diligence when we consider a company and its ethical, moral and social standing before it is added to our portfolio. Investors must ensure that they properly vet their investments on a large set of data and criteria. This is especially relevant as socially responsible investing (SRI) – directing capital toward companies limiting negative environmental impact and progressing social goals – continues its evolution into the mainstream.
The notion that environmental, social and governance (ESG) analysis is a complement to – but not a substitute for – fundamental analysis is nothing new. However, “ESG” has become somewhat of a buzz-term in the investment industry, with more investment products and managers scrambling to attract the growing population of investors interested in making an impact through their investments.
As more investors look to align their portfolios with environmental and social good, ESG data is being characterized as an indispensable tool for achieving SRI. But by relying solely on ESG data, investors are essentially just “checking the box.” This approach uses ESG as an exclusionary tool more closely associated with the concept of avoiding or divesting from “sin” industries.
This trend jeopardizes the incredible momentum that SRI has developed based on positive screening practices. Far more evolved than the early days of SRI, positive screening entails incorporating ESG considerations across all stages of the research and investment process to identify those companies that are strong both socially and financially.
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Using ESG ratings and rankings as only a quantitative tool can potentially roll back the progress made on positive screening, as it becomes easier to screen out all companies that do not meet pre-determined criteria. Investors run the risk of blurring the facts: They may not know if they are indeed investing in companies that are good corporate citizens or simply those with the best sustainability stories to tell.
Investors should, therefore, stick to the fundamentals of due diligence by researching and asking the right questions. This will help determine if ESG data is being used the way it is intended: as a more robust set of data that can help identify companies that are poised to achieve sustainable financial growth, improve the position of stakeholders, and identify some of the world’s most pressing environmental challenges.
At Reynders, McVeigh, we understand that companies face a diverse set of challenges and opportunities, which is why we use ESG data as a starting point that provides us with valuable information about where we need to focus our research. Each company is unique, therefore there is no one set of ESG factors that are material or pertinent to every organization’s long-term success. With this in mind, ESG data and rankings enable us to:
- Direct questions that help us better understand what makes a company truly sustainable
- Explore additional criteria that may be absent in reporting, such as how employees are compensated and how employees view their employer
- Investigate how the company manages environmental risks to ensure success not quarter to quarter, but five to ten years into the future
Relying solely on environmental, social and governance statistics to categorize companies as “best in class” compared to industry peers is inherently risky. It threatens an investment discipline that can lead to a more just, sustainable economy and planet for two primary reasons:
Currently, there is no regulation concerning the disclosure of ESG issues or other sustainability-related criteria. The lack of standardized reporting and consensus as to which non-financial issues are material continues to hinder an apples-to-apples comparison of companies within the same sector and across the economy. Although organizations such as the Sustainability Accounting Standards Board (SASB) are working to address the issues of standardization and materiality, inconsistencies across ESG data providers and researchers remain, according to a CSRHub study and analysis.
The issue of bias is another element that contributes to inconsistencies across research and ratings. Where one researcher may place more value on how much information is reported, another may be focused on which specific information is reported.
As corporate social responsibility (CSR) has become commonplace, companies are getting more familiar with not only how to report, but also what to report. Publishing information that shows a company in the best light possible in relation to ESG criteria neglects other information – both positive and negative – and fails to address issues that may be more material to a company and its business.
As we move forward in an improved world where companies are judged not only by their profits and shareholder returns, but also their integrity and positive impacts, it will be important to identify where gaps in ESG data exist and how analysis can be further used to identify companies that are efficient, well managed, and positioned for growth. If we merely rely on ESG data as an updated tool for the exclusion of companies, we will erase the progress made to evolve SRI.
DISCLAIMER: This material does not constitute investment advice and it should not be relied upon as such. Investment decisions should always be based on an investor's specific financial needs, objectives, goals, time horizon and risk tolerance. The opinions expressed in this material are subject to change and represent the current, good-faith views of Reynders, McVeigh Capital Management LLC. at the time of publication.