One of the biggest trends in global investing is the growth in environmental, social and governance (ESG) strategies. This generated even more interest following the 2020 election. Investors are looking for ways to invest in climate themes the current administration and Congress are looking to emphasize.
ESG investing has been around for decades. It initially was known as socially responsible investing or SRI, which typically excluded “bad actors” in stock selection. This focus, called “exclusionary,” initially received considerable pushback from experts. Famed economist Milton Friedman is credited for writing, “There is one, and only one, social responsibility of business — to use its resources and engage in activities designed to increase its profits so long as it stays within the rules of the game, which is to say, engages in open and free competition without deception fraud.” He also stated, investors want to maximize returns, and focus on value-based investing has not proven to have the same financial benefits.
Over time, the trend has been moving away from “exclusionary,” to ESG integration. Meaning, it’s not one or the other. This change is subtle, but meaningful. This difference: rather than focusing only on the negative, investors are emphasizing the positive. Grading factors for companies include their environmental impact, how they rate as a “corporate citizen” and governance. The theory is, if companies are good to their employees, community and the environment, they may also be managed well. Therefore, the belief is they generate better returns to shareholders.
According to Morgan Stanley, ESG investing now accounts for over $30 trillion in assets and continues to grow more than 25% per year; 85% of those assets are managed in Europe. Overall, investors’ concerns about performance have also declined. Credit Suisse reports that companies screening favorably on ESG metrics have performed better than the broader stock market averages. U.S. companies have outperformed the S&P 500 by over 3% per year in the last five years, while international companies have outperformed the EAFE index by over 5% per year. However, companies that have initially screened well on ESG have been in the technology sector, which may be helping this performance.
When you consider some of Idaho’s major employers, they look relatively positive. Micron screens favorably but can improve its opportunities in clean technology. Hewlett-Packard screens very well across metrics. When looking at the research for various companies, analysts rely on both public and private information; therefore, since Albertsons has only recently gone public, there isn’t enough information for an in-depth analysis. Looking at another large retailer in Boise, Walmart, there is room for improvement. Walmart screens below average, primarily due to its corporate governance and labor practices.
As both institutional and individual investors consider the ESG space, they have to be cognizant of what they are buying. There is over $1.8 trillion invested in ESG mutual funds and ETFs, and this is growing roughly $50 billion a month. Many ESG funds are heavily focused in growth stocks and may not offer the diversification investors are seeking. Also, ESG rankings have a high qualitative aspect to them, so there can be some inconsistencies in the rankings. There are several third-party research firms, such as MSCI, Sustainalytics and Bloomberg, that provide rankings. Also, investment firms may do their own internal analysis, which may also deliver a different result.
If investors are looking to invest in the ESG space, there are three things they should keep in mind: (1) having an understanding of how specific stocks are selected (2) knowing that company fundamentals are strong and (3) the portfolio is diversified. Due to strong demand, Ferguson Wellman launched a strategy three years ago that focuses on strong corporate financial health, high ESG metrics and global diversification.
This strategy has grown to $260 million in assets in three years, making it one of the fastest-growing investment strategies created and managed by our firm. If investors are looking to invest in the ESG space either for their own values, or to position the investments to align with any potential climate legislation, the key is to know what you own to ensure that you are not taking on any risk beyond your expectations.
In 2020, we led a discussion about the future of ESG investing from three perspectives: the analysis, corporate actions and fiduciary roles. No doubt, ESG investing will continue to evolve based on leadership in government, new company data and metrics and investor values and views. As with any investment strategy, your growth goals, risk tolerance and a focus on the long term will always help you make clear decisions on how you invest.
Jason Norris, CFA is a portfolio manager for Ferguson Wellman Capital Management’s Dividend Value, Core Equity and Global Sustainable Investing strategies.
This article is for informational purposes only and should not be viewed as advice or recommendations with respect to any particular investment.
Founded in 1975, Ferguson Wellman Capital Management creates customized investment portfolios for individuals and families as well as foundations and endowments. Ferguson Wellman serves clients with assets starting at $3 million and its division, West Bearing Investments has a minimum of $1 million.