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.

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. ESG evaluation is also very popular with women and millennials – two groups that continue to gain prominence in the investment world. This piece reviews ESG investing and provides ESG investment ideas. 

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 are now publishing detailed reviews of their ESG approaches in their annual reports.

    ESG Investing Growing at Rapid Pace 

    According to the Global Sustainable Investment Alliance, global ESG assets under management is growing at a 25% pace and now exceeds $23 trillion with 53% managed in Europe, 38% in the U.S., and less than 10% held around the rest of world. While Europe leads the world, ESG investing in the U.S. is growing at a rapid clip.

    Recently released data from the US SIF Foundation (a leading voice for ESG investing) found that sustainable, responsible and impact investing (SRI) assets now account for $12 trillion—or one in four dollars—of the $46.6 trillion in total assets under professional management in the U.S. This represents a 38% increase over 2016. From the first report in 1995, when assets totaled just $639 billion, to today, the sustainable and responsible investing industry has grown 18-fold and has matured and expanded across numerous asset classes.

    A diverse investor base holds the $12 trillion in U.S. ESG assets under management. This includes 496 institutional investors, 365 money managers and 1,145 community investing financial institutions. The largest percentage of money managers cited client demand as their top motivation for pursuing ESG incorporation, while the largest number of institutional investors cited fulfilling mission and pursuing social benefit as their top motivations.

    Money managers and institutions are utilizing ESG criteria and shareholder engagement to address a plethora of issues including climate change, diversity, human rights, weapons, and political spending.

    Table shows growing interest in ESG incorporation.

    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. 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 recent 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 woman board members, director meeting attendance, and board size.

    RobecoSAM (an investment company focused on ESG investments) annually evaluates more than 3,500 companies around the world for their ESG practices. RobecoSAM’s Corporate Sustainability Assessment rankings are included in Bloomberg’s database and incorporate many of the metrics discussed above. These scores also determine membership in the Dow Jones Sustainability Indices.

    Actionable ESG Investment Ideas 

    The stocks in the following list are all members of the Dow Jones Sustainability North America Index and score well in RobecoSAM’s Corporate Sustainability Assessment rankings.

     

    Stock or FundTickerSectorForward P/EEarnings Growth %Div Yield %Comments
    iShares MSCI ESG Optimized ETFESGULarge Blend--1.6Includes companies that have positive environmental, social, and governance characteristics
    Calvert Equity FundCEYIXLarge Growth--0.6The Calvert Principles for Responsible Investment guide management's investment research analysis and decisions
    Johnson & JohnsonJNJHealthcare17.982.5Leader in pharmaceuticals, medical device, and consumer products
    United Health GroupUNHHealthcare20.9121.4Largest managed care company in United States
    MicrosoftMSFTTechnology24.4121.7World's largest software developer, including Windows and Office
    Cisco SystemsCSCOTechnology15.5112.8Develops technologies across networking, security, collaboration, applications, and the cloud
    Walt DisneyDISCommunications Services14.9131.5Diversified global operations in theme parks, filmed entertainment, television broadcasting, and consumer products
    Procter & GamblePGConsumer Staples21.363.1Leading global marketer of household and personal care products
    Chevron CorpCVXEnergy14.1533.9Global integrated oil company is making progress on ESG metrics
    Duke EnergyDUKUtilities19.154.1Largest electric utility in US and making progress on ESG metrics
    3M Co.MMMIndustrials19.8122.8Diversified global firm providing coatings, sealants, and adhesives

    Source: Janney ISG, Bloomberg

    Disclaimer: 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.

    This is for informative purposes only and in no event should be construed as a representation by us or as an offer to sell, or solicitation of an offer to buy any securities. The factual information given herein is taken from sources that we believe to be reliable, but is not guaranteed by us as to accuracy or completeness. 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. Past performance is not indicative of future results. 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 within.

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