While ESG stands for “environmental, social and governance,” how do these elements play into corporate policies and procedures?
The environmental aspect takes into account both the positive and negative environmental impact of a company’s operation. A company may rate well if it has sound policies and measurable actions regarding climate change, greenhouse gas emissions, carbon footprint, water conservation, renewable energy, waste disposal, green products and technology, and environmental benefits for its employees. But a company with products or policies that are detrimental to the environment would likely score poorly in this category.
The social component relates to issues such as company culture and treatment and training of employees, hiring practices, diversity, and relationships with customers, consumers, and suppliers.
Governance involves areas such as executive compensation, policies and diversity of the board of directors, company oversight, and shareholder relations.
“Greenwashing” brings added scrutiny
With the rising interest in ESG has come increased scrutiny over the investment management industry’s ESG processes, research commitment, and, ultimately, portfolio construction. One aspect of this scrutiny is to ensure that investment management firms or mutual funds that purport to offer ESG strategies are true to that objective, and not just using ESG as a marketing tactic to increase assets under management – otherwise known as “greenwashing.”
Industry regulators, including the SEC, have been active in issuing statements and observations related to ESG processes and disclosures. This type of activity is expected to continue and likely increase with the rise in investor interest in ESG, the pace of ESG developments, and ongoing debate about whether there could be improved standards to compare practices among firms. Additionally, consulting firms and ratings firms have come out with opinions and guidance around this topic.
Are there investment benefits to ESG?
While ESG has taken root due, in part, to changing industry dynamics, its emergence has also contributed to those changing dynamics. This suggests that there may be opportunities for alpha generation when investing through an ESG lens.
For example, firms that address issues like climate change may be disrupting entire industries, like transportation. Consider the growth of electric vehicles as a case in point. This growth may encourage asset managers to evaluate the impact of electric vehicles on the entire value chain in search of opportunities. Companies in virtually any industry may also be employing capital to projects addressing ESG issues material to their business, which could create long-term value for shareholders and other stakeholders.
Incorporating ESG analysis is another dimension of risk management utilized while pursuing the optimization of client returns. It is this “middle ground” of ESG risk management where many large financial institutions, including Thrivent Asset Management, LLC (TAM), have begun to direct their focus.
For more information on ESG and TAM, please read “Thrivent Asset Management’s approach to ESG investing.”