Wall Street Letter VOL. XLV, No. 31 – Sept. 30, 2013 | Page 10

FEATURE

Adopting ESG factors
How traditional investment managers are looking at
environmental, social and governance (ESG) practices to identify
top-performing companies. By Emily Bannister, CFA and director
of research, and John LaPann, chairman, at Federal Street Advisors

EMILY BANNISTER

10

JOHN LAPANN

O

ver the last 20 years, the social
investing industry has grown
and changed. It has moved
from “negative screening”,
such as divesting from South
Africa or excluding “sin stocks”
from the portfolio, to a more positive approach that
favors good companies and can even improve companies through shareholder advocacy and lobbying.
Socially responsible investing (SRI) has also attracted more investors. According to US SIF (The
Forum for Sustainable and Responsible Investment),
SRI assets under management are up 22% from 2010
through 2012, to $3.74trn. Since 1995, SRI assets
have grown faster than professionally managed assets as a whole.
Unfortunately, we find that there are strategies
out there today that are “greenwashing” – marketing
themselves as environmentally friendly when in fact
their ESG criteria are not very strict. We also see a
number of products being launched that may have
good intentions, but may not have a good, disciplined investment process.
ESG FACTORS USED AS PART OF COMPETITIVE
ANALYSIS AND FUNDAMENTAL ANALYSIS
One indication that ESG factors are being adopted
by the broader investment community is that Michael Porter, creator of the influential “Porter’s Five
Forces” framework used by many traditional stock
analysts, recommends incorporating these factors
when assessing the competitive position of a company. When Porter highlighted the need for corporate
social responsibility to be considered in the analysis
of competitive advantage, it legitimized ESG analysis
for many mainstream investment professionals.
In turn, money managers are including these factors as data points that can help decide whether or not
they buy the stock of a particular company. Looking
at ESG trends can help investors find areas of growth,
identify firms that are cutting costs by being more efficient, and avoid reputational and economic risks.
INVESTORS FORMALLY INCORPORATE ESG
FACTORS IN THEIR RESEARCH PROCESS
There are increasingly high-profile examples of the
shift to include ESG factors as a way to boost re-

turns. Wellington Management, an investment firm
headquartered in Boston, MA that manages more
than $750bn in client assets, recently acknowledged
that ESG factors are increasingly important to consider when managing portfolios and risk and it has
developed tools to analyze ESG information because
it believes it can improve the investment process.
Other large, well-known asset managers have
made similar moves, also for economically-driven
reasons. Vanguard and BlackRock have both discussed plans to engage with hundreds of companies
on governance issues.
WHAT GETS MEASURED GETS DONE
Many companies now provide an annual Corporate
Sustainability Report as part of their regular reporting package to investors and stakeholders. To cater
to this new demand, accounting firms such as Ernst
& Young and PricewaterhouseCoopers offer services
to verify sustainability reporting. A major data provider to the investment industry, Bloomberg, now
tracks and reports ESG data points for all companies. Similarly, index provider MSCI, Inc. now offers
ESG research and ratings on companies.
Now that the watchdogs have started to focus
on these metrics, investors are more easily able to
measure and compare companies on issues that
were previously considered “soft.” As more investors
track these ESG factors and make decisions based on
them, they become more material to stock prices.
STRONG PERFORMANCE AND SUSTAINABILITY
OFTEN GO HAND IN HAND
In a world where outperforming the benchmarks is
a difficult feat, and active stock-pickers are always
searching for an edge, the strong performance delivered by firms with good environmental, social and
governance practices is reason enough for the lines
between “social investing” and “investing” to blur.
As the investment industry begins to embrace
this reality, we keep looking ahead to find forwardthinking money managers and perspectives to help
our clients achieve their goals. We believe that the
investment opportunities of tomorrow will continue
to be found in companies that are addressing the
opportunities and challenges of the future. Looking
at this future through an ESG lens can increase the
probability of success.
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