The growth orientation of ESG funds, at a time when value strategies roared back into popularity and performed strongly, have struggled to find many contenders.
Stocks within ESG funds have tended to congregate around certain sectors in certain niches and must display certain characteristics that are obviously beneficial to the environment and society. The approach by ESG managers of identifying the best in class is fully understandable and sits comfortably with investors who seek the same thing.
But the reality is globally there are many companies – in fact, the majority – that do not meet these high ideals. Embracing a sustainable and low-carbon future is going to require all companies to be involved.
In fact, if you believe you can use your capital to bring about positive change then there is a strong argument for engaging with and investing in those companies that have poor ESG/sustainability records, which aren’t doing the right thing but can be persuaded through shareholder pressure and legislation to transform their businesses. From some angles it makes more sense and will have a greater impact in bringing forward change by investing in these companies than it will by investing in companies that are already fully engaged with sustainability and carbon reduction.
Going down this route suggests that all companies could qualify for ESG portfolios, which in turn raises the spectre of greenwashing on a large scale. That is undeniably the case but of itself should not be a barrier to this type of thinking.
There is no industry standard for analysing companies and assessing their ESG credentials or their intentions and willingness to change despite there being mountains of ESG data provided by ratings agencies – much of this lacks consistency when consolidated into simple headline scores and indeed those headline scores don’t really provide much in the way of guidance.
This means the assessment of a company comes down to the analyst undertaking the work and the quality of their engagements. There are no set standards, and this does mean the rigour behind each engagement can vary considerably. But again, this shouldn’t be an impediment to taking this approach.
An intentionality framework
One possible framework that could be adopted and is used by some in the investment industry is the IMAP system developed by the Cambridge Institute of Sustainability and Leadership. This system looks at, for example, the intentionality of a company’s strategy and its commitment to it through spending.
Intentionality is not a new concept for ESG investors nor indeed is materiality that looks at the revenues generated by a company from their products and services. There is then the potential impact that a service or product has in the real world and the scale of it.
It’s an interesting thought that a large company making a small improvement in its processes/products could have a bigger impact than a small company in an ESG sweet spot. This helps to highlight why embracing all companies and seeking change is an important role for investors.
The other term commonly used is ‘additionality’, which is looking at the leadership a company takes in its area. The Cambridge Institute for Sustainability and Leadership has brought these four factors together into the IMAP system.
How the results of the analysis are used can be markedly different, but this is not necessarily a bad thing. Many companies would score quite poorly, which could be a fertile hunting ground for investors, and coupled with engagement could provide a robust framework.
If we accept that all companies need to change their behaviour to become more sustainable and less carbon intensive, and we can evidence their intentions, and accept that as an investor you can bring pressure to bear to encourage change, then the options for ESG investors will open up considerably.