ESG Investing: 5 Top Questions Answered

05.06.2021 - Jeff Finkelman, Senior Research Analyst

Environmental, social, and governance (ESG) investing has been gaining considerable momentum among many investors. We recently sat down with Jeff Finkelman, Vice President, Sustainable Investing, to learn more about this exciting and growing investment approach.

Why do you think ESG has become more of a focus for investors today?

While interest in ESG investing has been gaining momentum for some time, the events of 2020 have, in our view, accelerated the trend for three main reasons.

First, the pandemic demonstrated how vulnerable the global economy can be to external shocks. While ESG investors did not anticipate the outbreak of COVID-19, they have long argued that integrating ESG factors into the decision-making process can help enhance the resilience of an investor’s portfolio over the long term. Companies that are attuned to the needs of all their stakeholders, the thinking goes, are more likely to retain customer loyalty, maintain a productive workforce, make prudent capital allocation decisions, and ultimately deliver better returns for their shareholders. It’s a philosophy that bears many similarities with “quality investing.”

Second, because many ESG strategies came to market during the bull market following the Great Financial Crisis, it may have been somewhat easy to dismiss them as “untested.”  But when a number of ESG strategies outperformed their traditional peers during the sharp selloff in March 2020 and then kept pace during the ensuing rebound, skeptics were forced to take the approach more seriously. 1

Finally, both the pandemic and the racial justice demonstrations last summer cast a light on certain inequities that exist in American society. With those issues in mind, we think investors’ appetites for strategies that consider the social and environmental context in which a business operates have likely grown.

In reference to ESG investing we often hear about “greenwashing.” Can you explain what that term means?

Sustainable investing has a long history, but it has really only been in the past two to three years that investment flows into ESG-labelled products have skyrocketed. If you are a company seeking to boost your share price or an asset manager eager to grow, there is a temptation to align with the trend. What we have discovered is that it is pretty easy for a firm to recast its investment strategy as “sustainable” without making any real change to the way it does business—that’s “greenwashing."

Greenwashing has certainly muddied the investment waters. It used to be easy to find sustainable investment strategies because they generally had “ESG” in their names. That is no longer true. ESG has gone from being an investment theme, practiced by a small sub-set of managers, to an increasingly sophisticated and widespread investment practice. It is an exciting development, but it makes it harder to discern the “authentic” from the “greenwashed.”  It can be helpful to have an advisor with a deep commitment to the space to help navigate the landscape.

But I also think that concerns about greenwashing reflect the continued lack of consensus, even within the sustainable investing community, about the proper role of ESG analysis in the investment process. Is it to ensure the resulting portfolio only holds companies with the best ESG rankings?  Or is it to ensure the investment manager remains aware of, but not beholden to ESG factors that might affect financial performance?  At times, I think accusations of “greenwashing” stem more from differences of opinion on those questions, rather than concerns about deceptive marketing practices.

When working with outside investment managers, how do you analyze their approach to ESG?

ESG investing is such a rapidly evolving field and there is so much variation in the way ESG data is used that we think it is imprudent to apply strict criteria to the assessment of a given manager’s approach to ESG. Our evaluation criteria differ depending, among other things, on whether the strategy is actively or passively managed and the asset class in which it operates.

Nonetheless, we do maintain certain principles. When evaluating actively managed strategies, for example, we look for five key traits:

  1. Authenticity: We search for evidence that the investment team truly believes that ESG analysis improves their investment process and enhances their understanding of a given company’s core value proposition. We are generally wary of actively managed strategies that appear subject to top-down mandates. We prefer working with investment teams that have developed an approach to ESG integration that is tailored to their unique investment style.
  2. Materiality: We focus our due diligence process on understanding how ESG data and analysis is used to influence investment decisions. We are fiduciaries, so unless we are working to fulfill a specific client’s values-driven mandate, financial materiality must be at the core of the team’s ESG analysis. Skilled managers are able to sift through ESG data, determining what is and is not relevant to company performance.
  3. Capacity: Our team favors managers that have committed sufficient resources to fully research and assess the ESG issues relevant to their investment portfolios. Subscribing to an ESG ratings provider is not enough.
  4. Accountability: We pay close attention to team structure and the way decisions about ESG issues are made. Some firms support their investment teams with centralized ESG research teams, which can be an effective approach. But we believe it is essential that the portfolio managers and individual security or sector analysis are held accountable for decisions about the weight ESG factors are given.
  5. Transparency: The quality and availability of ESG data remains a major challenge for sustainable investors, but we prefer managers that provide periodic reports explaining the effects ESG integration is having on the portfolio.
What role can passive ESG strategies play for an investor?

These strategies can often provide an ESG “tilt” within an existing portfolio, meaning that the portfolio can be weighted towards companies that have higher ESG ratings. Passive ESG strategies are often most useful as a tool of alignment because they use systematic rules to ensure the strategy maintains a certain ESG or values-based profile.

Are there any specific areas where you see new ESG strategies emerging?

Although it may not offer the largest opportunity set for sustainable investors, we think hedge funds are an interesting asset class for ESG investors. In the past few years, several new ESG-focused hedge fund strategies have launched. On the activist side, a number of firms have launched strategies that place ESG at the core of their value-creation thesis. For that reason, we think these funds may actually belong in the “impact” category rather than ESG as they embrace an activist approach to affecting change. Further, improvements in ESG data quality have facilitated the use of ESG data in quantitatively driven strategies. While this is currently a small category, we expect it to expand in the years ahead.

1.  “Why ESG investing makes fund managers more money,” Gillian Tett, 7/9/2020

The information provided is intended solely to provide general information. The information and opinions stated may change without notice. The information and opinions do not represent a complete analysis of every material fact regarding any market, industry, sector or security. Statements of fact have been obtained from sources deemed reliable, but no representation is made as to their completeness or accuracy. The opinions expressed are not intended as individual investment, tax or estate planning advice or as a recommendation of any particular security, strategy, or investment product. Please consult your personal advisor to determine whether this information may be appropriate for you. This information is provided solely for insight into our general management philosophy and process. Historical performance does not guarantee future results and results may differ over future time periods.


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