By The CGC Team
While ESG was a somewhat niche term a decade ago, it would be rare to find a manager or allocator of capital today who has not heard of the term.
While the integration of material ESG issues at its core is about widening the aperture you look through when assessing an investment for both expanded due diligence and value creation, there is no clear consensus on how, where, or when to integrate environmental, social and governance issues into an investment process, if at all.
The politicization of ESG has created an additional level of complexity for some market participants (see part 2 of this series “Some reasons why ESG has become a target for politicization, and why it doesn’t matter”). Adding to the confusion is the conflation between Impact and ESG, claims of “greenwashing” from ESG labeled funds, and the difficulty valuing the financial performance of material ESG issues as these can often be qualitative and sometimes even subjective in nature.
Given the confusion and noise in the market – what can investors do today to ensure that they are fulfilling their duties as stewards of capital?
Forget about labels, acronyms, politics, and everything you have heard about ESG, and ask 5 fundamental questions for all your investment strategies:
1. What is the intention of the strategy?
The intention of a strategy can be thought of as the specific goals & objectives of the strategy.
Is the intention to preserve capital, track a market index, maximize short or long term risk adjusted returns, beat an absolute benchmark, reduce carbon emissions, minimize natural capital impacts, increase diversity of companies, etc., or is the intention a mix of some / all of these?
2. What are the prevailing global mega trends?
Current trends include global inflation, supply chain risks, resource scarcity, the climate crisis, civil, civic, & equality movements, and labor shortages, among others.
Will the strategy capitalize on the trends and/or has the strategy sufficiently hedged these trends to meet the investment goals and objectives?
3. How resilient is the strategy?
Will the strategy meet its goals and objectives through different economic environments?
Will the assets remain financially and operationally resilient through disruptions from major events such as climate-related disasters?
4. What are the material underlying risks (opportunities)?
How are risks being identified and mitigated? How are opportunities being leveraged?
Who are the stakeholders for each issue?
Is there an understanding of the financial impacts of the material issues for each investment, including the tangible and intangible factors (where often E, S, and G issues reside)?
5. What are the outcomes of the strategy?
Is the intention of the strategy reflected in the holdings and exposures of the strategy? Are the objectives and goals of the strategy being met?
What are the positive and negative externalities created by each investment within the strategy?
For asset managers a 6th question, of equal importance, needs to be asked:
How is the strategy being marketed?
Is the intention of the strategy clear from the description and disclosures? Do investors understand the intention, risks/opportunities & externalities of the strategy?
Is it what is being said, being done, and is what is being done, being said?
By answering these fundamental questions investment managers and allocators of capital can confidently move away from the rhetoric, politics, and acronyms, to the more important goal of ensuring that they have a thorough understanding of how all investment factors, including material E, S, and G factors are integrated across the strategy, either for risk mitigation, for value creation, for achieving an investment goal or objective, and/or any combination of these. Ultimately, this is the duty and responsibility of all managers, stewards, and allocators of capital.