Ain’t Nothin But a (ES) G Thang

By HMA Team on January 30, 2020

After the Deepwater Horizon oil spill, BP stock fell 51% over the course of 40 days[1]. In 2013, the stock of Asics Corp slid for the better part of a month after a Cambodian factory collapsed which made some of its shoes. It’s no secret that harmful accidents, in addition to hurting people and the environment, can also take a chunk out of a company’s stock price. Not only is there bad publicity, but companies will often have to pay hefty fines and make costly improvements after an issue arises. As an investor, it can make sense to try to avoid investing in companies that practice poor policy. This is where Environmental, Social, Governance (ESG) investing comes into play. The term has been gaining traction since the mid 2000s. But what, exactly, is ESG investing and why is it important? Also, as an HMA client, how is it being enacted in your portfolio?

Many people confuse ESG investing with Socially Responsible Investing (SRI). However, these two terms are not interchangeable. SRI will often focus on avoiding companies that deal in areas that can be viewed by some people as morally or ethically lacking, like alcohol or firearm manufacturers. However, ESG investing enacts a set of positive criteria used to assign companies scores based on how well they follow certain metrics, such as being environmentally responsible, providing good conditions for workers, and enacting proper corporate accountability and oversight.

Each letter means something specific and houses its own distinct set of screening criteria. Under the “E” in ESG, you’ll find things such as energy usage, material sourcing, supply chain management, and regulatory and legal risks. The “S” references items such as community relations, union relationships, health and safety, and human capital management. The “G” is also pretty key. Who hasn’t heard of the company that loses a chunk out of its stock price because of a leadership scandal? Governance refers to things such as board structure and size, anti-takeover measures, executive compensation methods, transparency, and shareholder rights.

Taken together, these criteria can measure how “sustainable” a company is. Essentially, “sustainability” in this context means how resistant a company is to being taken down by an accident, lawsuit, or some other negative event resulting from unsavory or questionable practices. A company’s sustainability score has been linked to how profitable it can be in the long run. In a landmark study conducted in 2013[2], a link between sustainability and shareholder value was created and has been reinforced several times since. The connection is clear, companies that make smart use of resources, treat their people well, and run a tight ship tend to be around longer and can generate more value for shareholders. This is because they often have better production due to decreased employee turnover, accumulate fewer costs associated with regulatory fines or wasteful practices, and maintain competent and consistent leadership that shareholders can have faith in.

At HMA, we incorporate the belief that sustainable companies can deliver strong returns into our investment practices. We currently utilize two of the top ESG rating services, MSCI and Sustainalytics, and are working on ways to integrate more of their data into our investment processes. We believe this information is important and we will continue to investigate a company’s use of resources, human capital policies, and governance practices before placing a stock in the actively managed portion of our client’s portfolios. When selecting mutual funds, we have thorough discussions with the fund company representatives regarding their ESG and fund management practices. Our aim is to strike a balance between sustainability and strong returns. We don’t believe one should ever be sacrificed in the name of the other.

A well-crafted portfolio, with a mindful mix of sustainability, risk, and return: That’s HMA!

[1] https://en.wikipedia.org/wiki/Economic_effects_of_the_Deepwater_Horizon_oil_spill

[2] https://arabesque.com/research/From_the_stockholder_to_the_stakeholder_web.pdf