(Envestnet) ESG integration is incorporating material information into the investment process. It is not a war against the energy sector and it is not a mechanism to promote a political ideology.
When you look at what ESG information actually is, it is data and metrics that support investment analysis in a 2022 economy. It’s more information to better evaluate dimensions that increasingly drive valuations – like human capital, corporate culture, reputation, and brand value.
ESG integration is also a framework to better understand externalities, which all companies have. Externalities are costs to society that companies haven’t paid for, and benefits to society that companies haven’t fully considered. A major change for companies in recent years is that these externalities are becoming increasingly rare. What was once extraneous to a business is increasingly affecting company bottom lines and shareholder value creation.
Taking it to an individual level, when we think about our day-to-day lives, we are:
- Seeing an increased frequency of more destructive wildfires, hurricanes, and droughts
- Reading about communities that continue to struggle to get access to clean water
- Experiencing a global pandemic that health care systems everywhere were woefully unprepared for
- Witnessing supply chain disruptions caused by labor shortages and protests around fair wages and treatment
- Watching debates about free speech, content moderation, and concerns about data privacy
- Feeling the effects of rapid inflation amidst a contentious geopolitical landscape
These issues impact our lives and they also impact the companies in our portfolios.
The term ESG has been misinterpreted by some, but the reality is, investment teams, regardless of personal or political beliefs, are paying attention to material risks in their investment decisions. ESG information can shed light on a company’s ability to remain competitive, because, for example:
- Strong management of employees can result in lower turnover and higher productivity
- Better relationships with the communities where companies operate can reduce the likelihood of lawsuits and operational disruptions
- Water and waste efficiencies can reduce operational costs
- Consumer trust is essential to maintaining a social license to operate
- Companies have an impact on the climate through emissions and resource depletion, and that the climate impacts companies through operational disruptions and asset stranding
These are fundamental investment considerations where ESG information can offer insights. When we talk to asset managers, that’s their view. We cannot ignore this information and continue to fulfill fiduciary duty in today’s economy.
In the new year, we’ll look at a handful of industries and the ESG issues they’re faced with, in an effort to better demonstrate what ESG analysis looks like in the real world. Stay tuned.
