Environmental, Social, and Governance (ESG) investing is a rapidly growing investment discipline that includes many factors that make up traditional corporate best practices. Consequently, many firms that score well on ESG metrics are also solid investment opportunities. While ESG evaluation is popular with women and millennials—two groups that continue to gain prominence in the investment world—it continues to gain importance for all investors. This piece reviews ESG investing.

Definition of Environmental, Social and Governance (ESG) Investing

Environmental, Social and Governance (ESG) investing (also referred to as sustainable, responsible and impact investing or socially responsible investing) utilizes a set of standards for a company’s operations that socially conscious investors use to screen potential investments.

  • Environmental criteria look at how a company performs as a steward of the natural environment.
    • Examples include energy and water use, waste, pollution, natural resource conservation, and impact on climate change or carbon emissions.
    • They also evaluate which environmental risks might affect a company’s income and how the company is managing those risks.
  • Social criteria examine how a company manages relationships with its employees, suppliers, customers, and the communities where it operates.
    • Do the company’s working conditions show a high regard for its employees’ health and safety?
    • Does the firm employ a diversified work force? Is the Board of Directors well diversified?
    • Are stakeholders’ interests taken into consideration (stakeholders include employees, creditors, shareholders, government, and the community from which the business draws its resources)?
    • Does it work with suppliers that hold the same values the company claims to hold?
  • Governance deals with a company’s leadership, executive pay, audits, internal controls and shareholder rights.
    • Does the firm use accurate and transparent accounting methods?
    • Do common stockholders have the ability to vote on important issues?
    • Does the firm avoid conflicts of interest in the choice of board members?
    • Does the firm avoid engaging in illegal behavior or using political contributions to obtain favorable treatment?

What constitutes an acceptable set of ESG criteria is typically subjective, so investors must do research to find investments that match their own values. As ESG-minded business practices gain more traction, firms are increasingly tracking their ESG progress. Many firms publish detailed reviews of their ESG approaches in their annual reports and work is being done to standardize reporting—studies show significant divergences in ESG ratings across providers.

ESG Investing Growing at Rapid Pace 

While Europe leads the world, ESG investing in the U.S. is growing at a rapid clip. The US SIF Foundation (a leading voice for ESG investing) found that sustainable, responsible and impact investing (SRI) assets accounted for $17.1 trillion—or one in three—of the $51.4 trillion in total assets under professional management in the U.S., as of year-end 2019. This represents a 42% increase over two years. From the first report in 1995, when assets totaled just $639 billion, to today, the sustainable and responsible investing industry has grown 27-fold and has matured and expanded across numerous asset classes.

A diverse investor base holds the $17 trillion in U.S. ESG assets under management including more than 530 institutional investors, 384 money managers, and 1,204 community investing financial institutions. Money managers cite client demand as a top motivation for pursuing ESG incorporation, while institutional investors cite fulfilling mission and pursuing social benefit as motivations. The importance of transitioning to a low-carbon economy, as well as human capital management, diversity, and health and wellness are seen as priority issues for the coming years. While climate change has become a leading issue, ESG criteria and shareholder engagement are being used to address many other issues including human rights, weapons, political spending, and other governance factors.

Studies Suggest a Link Between Corporate Social Responsibility Practices and Financial Performance 

Many research studies have demonstrated that companies with strong corporate social responsibility policies and practices are sound investments. Studies with such findings have come from Oxford University, Deutsche Asset & Wealth Management, Morgan Stanley Institute for Sustainable Investing, TIAA-CREF Asset Management, and Morningstar, among others.

With the recent availability of higher-quality company-level ESG data, researchers have been able to dive deeper into the relationship between corporate sustainability practices and financial performance. These studies show a number of positive relationships between companies that employ best practices addressing ESG factors that face their businesses and financial performance — whether measured in terms of financial results or stock price. This is in contrast to utilizing purely exclusionary screens (for example, broadly screening out “sin stocks”) which can have a negative impact on a portfolio.

Part of the challenge of ESG investing today is the breadth of topics spanned in corporate ESG disclosures with hundreds of metrics available to investors. This has led to variations in different ESG ranking systems. The Sustainability Accounting Standards Board (SASB) and others are actively developing sustainability accounting standards to help companies disclose material information in SEC filings in a way that is decision-useful for investors. The most useful ESG data can give insight into a company’s culture and risk and typically coincides with corporate best practices.

The following table reviews several key metrics available for ESG investors.

ESG Metrics Give Insight into Corporate Culture and Typically Correspond with Best Practices
TopicApplicable InsightRelevant ESG Measures

Human Capital

Are employees happy and productive?
Is the company an employer of choice?
Does the company avoid expensive turnover?

Employee turnover, training hours, average compensation, diversity, etc. 

Operational Excellence

Does the firm use resources efficiently?
Are working conditions safe?
Does the firm employ appropriate controls to avoid accidents and controversies?

Injury rates, energy usage, water usage, waste recycling, etc.

Company Reputation

Are the firm's products safe and environmentally friendly?
Does the firm protect customer data and privacy?
Does the firm provide poor customer service?

Renewable energy usage, in-kind product donations, product take-back rates, etc. 

Regulatory Risk

Does the firm have strong ethical practices?
Are production activities harmful to the environment?
Does the firm maintain good community relations, including labor practices, ecological impact, and product pricing?

Emissions, whistleblower incidents, fines and settlements, etc.

Factors That Correlate Best With Stock Performance

A study by Goldman Sachs showed that many ESG factors that are associated with happy employees and efficient resource utilization are also positively correlated with stock performance.

ESG Factors that Correlate Best with Stock Performance
DiversityCompanies with higher levels of female employees have shown outperformance across many industries.
Resource IntensityFirms with low levels of energy and water intensity have performed well, especially for Basic Resource sectors (some of the largest users of energy and water).
Employee TurnoverCompanies with low employee turnover have generally outperformed their peers.
EmissionsLow emitters based on greenhouse gas emissions have generally outperformed their peers.
Target Metrics"Target" metrics as a category (stated goals on ESG performance) were consistently linked to outperformance over time - specifically those related to emissions, energy, and water efficiency.
Business Ethics Improvement ToolsThis category (including whistle blower, ombudsman, suggestion box, hotline, etc) is one of the few pure policy (non-quantifiable) metric that was consistently linked to stock outperformance.

Source: Janney ISG, Goldman Sachs

ESG Analysis Tools 

Due to the significant growth in ESG investing, investment analysis tools are becoming commonplace. Bloomberg (a provider of business and market news, data and analysis) now has an extensive database of ESG metrics, rankings and analysis. These can be used to assess a company's environmental, social, and governance performance, both over time and versus its peers.

Environmental metrics include factors like greenhouse gas emissions per revenue. Social metrics include factors like percent of women employees, employee turnover, and lost time to incident rate. Governance metrics include factors like percent of independent directors, percent of women board members, director meeting attendance, and board size.

S&P recently purchased RobecoSAM (an investment company focused on ESG investments) which annually evaluates more than 3,500 companies around the world for their ESG practices. Morningstar owns Sustainalytics, a provider of company-level ratings, and has developed a broad ESG platform, including fund and portfolio level analysis. Both S&P and Morningstar rankings are part of Bloomberg’s database and incorporate many of the metrics discussed above.

S&P’s rankings also determine membership in the S&P Dow Jones Sustainability Indexes. MSCI is also a major provider of ESG rankings and produces ESG indexes. These indexes are used for portfolio benchmarks, as the basis for exchange traded funds, and as part of the portfolio creation process.

Disclaimer:

This report is provided for informational and educational purposes only and shall in no event be construed as an offer to sell or a solicitation of an offer to buy any securities or a recommendation for any strategy or to buy, sell, or hold any product. Opinions expressed are subject to change without notice and do not take into account the particular investment objectives, financial situation, or needs of individual investors. Employees of Janney Montgomery Scott LLC or its affiliates may, at times, release written or oral commentary, technical analysis, or trading strategies that differ from the opinions expressed here. The information described herein is taken from sources which we believe to be reliable, but the accuracy and completeness of such information is not guaranteed by us. The opinions expressed herein may be given only such weight as opinions warrant. This Firm, its officers, directors, employees, or members of their families may have positions in the securities mentioned and may make purchases or sales of such securities from time to time in the open market or otherwise and may sell to or buy from customers such securities on a principal basis. This report is the intellectual property of Janney Montgomery Scott LLC (Janney) and may not be reproduced, distributed, or published by any person for any purpose without Janney’s prior written consent. This presentation has been prepared by Janney Investment Strategy Group (ISG) and is to be used for informational purposes only. In no event should it be construed as a solicitation or offer to purchase or sell a security. Past performance is no guarantee of future performance and future returns are not guaranteed. There are risks associated with investing in stocks such as a loss of original capital or a decrease in the value of your investment. For additional information or questions, please consult with your Financial Advisor.

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