ESG and other labels of the new world of investment

Sustainable investing requires familiarity with a dizzying list of acronyms, but don’t be put off.

ESG and what it means - The Deal

Sustainable investing requires familiarity with a dizzying list of acronyms so arcane you might think they originated with bureaucrats. Truth be told, many of them did. ESG. UNGC. SDG. PRI. TCFD. That’s not including SASB and GRI. Don’t be put off: Sustainable investors should know what they mean.

First, allow us to lift the veil. You may already know that ESG stands for environmental, social, and governance investing — an array of nonfinancial factors that expresses a company’s behavior. In fact, ESG made its first appearance in a report called Who Cares Wins, published by the United Nations Global Compact (the aforementioned UNGC), more than 15 years ago.

The UNGC is a voluntary initiative of companies that began in 2000, based on 10 principles in the areas of human rights, labour, the environment and anti-corruption. In 2015, it launched 17 sustainable development goals, or SDGs, such as universally available clean water and eradicating hunger and poverty. The SDGs have 223 metrics by which improvement could be measured year by year, and are increasingly used as benchmarks by impact investors, who try to achieve social outcomes in addition to financial returns.

More: ESG — what it really means | ESG, coming ready or not

New UN-backed initiatives followed. In 2006 came the Principles for Responsible Investment, which investors and investment managers enthusiastically signed. The PRI recognised that ESG issues like climate and human rights could affect investment performance.

Investors have long realised that they need reporting standards for companies to disclose their approach to these issues. In 1997 came the Global Reporting Initiative, which suggested standards for sustainability reporting. Then there was the Sustainability Accounting Standards Board, an organisation with voluntary guidelines for companies to report sustainability issues that are financially material to investors. Late last year, the SASB published a comprehensive list of 77 industry-specific standards regarding financially material factors that could affect the financial condition or operating performance of a company.

Others pushed for companies to disclose more, particularly about their effects on the environment. United Kingdom–based CDP, formerly the Carbon Disclosure Project, pushed global companies to disclose environmental information such as water and energy use. So did the Task Force on Climate-Related Financial Disclosures, born in 2015 after Bank of England governor Mark Carney said climate change was the “tragedy of the horizon” that was a defining issue for financial stability.

‘Part of the problem is sustainability means different things to different people’

All these frameworks might make you think that ESG data is abundant, standardised, widely accepted and widely available. Think again. “It’s super-nuanced and super-difficult — even professionals have a hard time,” confesses Frances Tuite of AMG Managers Fairpointe ESG Equity fund. “Trying to get the data is difficult and takes a lot of work. That’s why you need active management.” Part of the problem is sustainability means different things to different people. That’s why the SASB took so long to publish its comprehensive list of industry-specific materiality factors.

The most important SASB data, according to Bud Sturmak, an advisor responsible for investment due diligence at New Jersey-based RLP Wealth Advisors, is its disclosures. Thanks to the materiality maps, “you can see the five or six things that matter for each industry”, he says. “We aren’t at a point, unfortunately, where you have broker reports that tell you how each company scores on the SASB framework. There’s lots of hands-on research required.”

Plenty of companies report SASB-type data, but not in any standardised manner. In 2017, according to the SASB’s most recent survey on disclosure, 83 per cent of companies surveyed included some form of SASB disclosure, while 73 per cent report on at least 75 per cent of the sustainability topics included in their industry’s SASB standard. The trouble is that most of these aren’t provided in standard format. Most companies release this information in a variety of pamphlets and other communications, including the glossy corporate social responsibility report.

They aren’t required for the 10-K, for example, the comprehensive report that US-listed companies file every year to the Securities & Exchange Commission about their financial performance, business, subsidiaries, strategy and structure. The CSR is a much more attractive document, but doesn’t have the same level of auditing. Partly, it’s because companies worry about making forward-looking statements about efficiency improvements. SASB itself, which once pushed companies to include disclosures in the 10-K, is now backing off, on the theory that companies can be much more candid in the CSR. Today, only a handful of companies report SASB data in their 10-Ks, including Etsy and Vornado Realty Trust. Nike has an SASB table in its investor-relations landing page. JetBlue and NRG Energy are producing standalone SASB reports. That’s the big companies we’re talking about. “I’m guessing less than 20 per cent of companies are SASB-compliant,” says Bruno Bertocci, who leads UBS Asset Management’s sustainability equity group.

‘ESG is not a silver bullet’

So is it worth all this trouble? Well, yes. ESG represents material, non-financial data that in theory leads to alpha. Using it doesn’t mean you’re a master investor, of course. “ESG is not a silver bullet,” says Jackie VanderBrug, head of sustainable investment strategy at Bank of America.

Still, it represents all kinds of data outside what are governed by Reg FD. “This isn’t new stuff,” says Bertocci. “The quality of management. The competitive position. All these things you should talk about.”

If you want companies that are well positioned over the next 10 to 20 years, you might pick sectors: own fewer fossil-fuel companies, for example, or be pickier about airlines, which put out huge amounts of emissions. “The question for the average investor buying an airline stock is to make sure it has efficient planes,” says Jonathan Bailey, head of ESG investing at Neuberger Berman. JetBlue’s sustainability report, Bailey points out, discloses emissions per seat mile flown as well as safety data.

Jerome Dodson, founder of Parnassus Investments, a top-performing investor, deploys a Warren Buffett–like value style, buying only companies that he believes treat employees and the environment well. Happier workers are more productive; conserving energy, water, and materials saves money.

The SEC shows no sign of moving to require sustainability disclosures, even though it’s routinely asked by the industry to do so. In 2017, Vanguard’s then-chairman Bill McNabb asked companies to “embrace the disclosure of sustainability risks that bear on a company’s long-term value-creation prospects”, and cited SASB standards as a suitable framework. Similarly, BlackRock’s Fink has argued ESG factors “can provide essential insights into management effectiveness and thus a company’s long-term prospects”. Last year, US senator Elizabeth Warren proposed a bill to require public companies to disclose critical information about their exposure to climate-related risks.

The corporate bureaucrats are ahead of the governmental ones here. Recently, twp new IPOs, Lyft and Zoom Video Communications, reportedly were mulling disclosures outlining their performance on ESG goals.