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A Guide to Environmental, Social, and Governance (ESG) Investing

Environmental, Social, and Governance (ESG) investing is a rapidly growing investment discipline that includes many factors that make up traditional corporate best practices. Consequently, many firms that score well on ESG metrics are also solid investment opportunities.

January 2, 2019 (Philadelphia)

Environmental, Social, and Governance (ESG) investing is a rapidly growing investment discipline that includes many factors that make up traditional corporate best practices. Consequently, many firms that score well on ESG metrics are also solid investment opportunities. ESG evaluation is also very popular with women and millennials – two groups that continue to gain prominence in the investment world. This piece reviews ESG investing and provides ESG investment ideas. 

Definition of Environmental, Social and Governance (ESG) Investing
Environmental, Social and Governance (ESG) investing (also referred to as sustainable, responsible and impact investing or socially responsible investing) utilizes a set of standards for a company’s operations that socially conscious investors use to screen potential investments.

• Environmental criteria look at how a company performs as a steward of the natural environment.
o Examples include energy and water use, waste, pollution, natural resource conservation, and impact on climate change or carbon emissions.
o They also evaluate which environmental risks might affect a company’s income and how the company is managing those risks.
• Social criteria examine how a company manages relationships with its employees, suppliers, customers, and the communities where it operates.
o Do the company’s working conditions show a high regard for its employees’ health and safety?
o Does the firm employ a diversified work force? Is the Board of Directors well diversified?
o Are stakeholders’ interests taken into consideration (stakeholders include employees, creditors, shareholders, government, and the community from which the business draws its resources)?
o Does it work with suppliers that hold the same values the company claims to hold?
• Governance deals with a company’s leadership, executive pay, audits, internal controls and shareholder rights.
o Does the firm use accurate and transparent accounting methods?
o Do common stockholders have the ability to vote on important issues?
o Does the firm avoid conflicts of interest in the choice of board members?
o Does the firm avoid engaging in illegal behavior or using political contributions to obtain favorable treatment?

What constitutes an acceptable set of ESG criteria is typically subjective, so investors must do research to find investments that match their own values. As ESG-minded business practices gain more traction, firms are increasingly tracking their ESG progress. Many firms are now publishing detailed reviews of their ESG approaches in their annual reports.

ESG Investing Growing at Rapid Pace 
According to the Global Sustainable Investment Alliance, global ESG assets under management is growing at a 25% pace and now exceeds $23 trillion with 53% managed in Europe, 38% in the U.S., and less than 10% held around the rest of world. While Europe leads the world, ESG investing in the U.S. is growing at a rapid clip.

Recently released data from the US SIF Foundation (a leading voice for ESG investing) found that sustainable, responsible and impact investing (SRI) assets now account for $12 trillion—or one in four dollars—of the $46.6 trillion in total assets under professional management in the U.S. This represents a 38% increase over 2016. From the first report in 1995, when assets totaled just $639 billion, to today, the sustainable and responsible investing industry has grown 18-fold and has matured and expanded across numerous asset classes.

A diverse investor base holds the $12 trillion in U.S. ESG assets under management. This includes 496 institutional investors, 365 money managers and 1,145 community investing financial institutions. The largest percentage of money managers cited client demand as their top motivation for pursuing ESG incorporation, while the largest number of institutional investors cited fulfilling mission and pursuing social benefit as their top motivations.

Money managers and institutions are utilizing ESG criteria and shareholder engagement to address a plethora of issues including climate change, diversity, human rights, weapons, and political spending.

Studies Suggest a Link Between Corporate Social Responsibility Practices and Financial Performance 
Many research studies have demonstrated that companies with strong corporate social responsibility policies and practices are sound investments. Studies with such findings have come from Oxford University, Deutsche Asset & Wealth Management, Morgan Stanley Institute for Sustainable Investing, TIAA-CREF Asset Management, and Morningstar, among others.

With the recent availability of higher-quality company-level ESG data, researchers have been able to dive deeper into the relationship between corporate sustainability practices and financial performance. These studies show a number of positive relationships between companies that employ best practices addressing ESG factors that face their businesses and financial performance — whether measured in terms of financial results or stock price. This is in contrast to utilizing purely exclusionary screens (for example, broadly screening out “sin stocks”) which can have a negative impact on a portfolio.

Part of the challenge of ESG investing today is the breadth of topics spanned in corporate ESG disclosures with hundreds of metrics available to investors. The most useful ESG data can give insight into a company’s culture and risk and typically coincides with corporate best practices. The following table reviews several key metrics available for ESG investors.

Factors That Correlate Best With Stock Performance
A recent study by Goldman Sachs showed that many ESG factors that are associated with happy employees and efficient resource utilization are also positively correlated with stock performance.

ESG Analysis Tools 
Due to the significant growth in ESG investing, investment analysis tools are becoming commonplace. Bloomberg (a provider of business and market news, data and analysis) now has an extensive database of ESG metrics, rankings and analysis. These can be used to assess a company's environmental, social, and governance performance, both over time and versus its peers.

Environmental metrics include factors like greenhouse gas emissions per revenue. Social metrics include factors like percent of women employees, employee turnover, and lost time to incident rate. Governance metrics include factors like percent of independent directors, percent of woman board members, director meeting attendance, and board size.

RobecoSAM (an investment company focused on ESG investments) annually evaluates more than 3,500 companies around the world for their ESG practices. RobecoSAM’s Corporate Sustainability Assessment rankings are included in Bloomberg’s database and incorporate many of the metrics discussed above. These scores also determine membership in the Dow Jones Sustainability Indices.

Actionable ESG Investment Ideas 
The stocks in the following list are all members of the Dow Jones Sustainability North America Index and score well in RobecoSAM’s Corporate Sustainability Assessment rankings.

Disclaimer: Past performance is no guarantee of future performance and future returns are not guaranteed. There are risks associated with investing in stocks such as a loss of original capital or a decrease in the value of your investment.

This is for informative purposes only and in no event should be construed as a representation by us or as an offer to sell, or solicitation of an offer to buy any securities. The factual information given herein is taken from sources that we believe to be reliable, but is not guaranteed by us as to accuracy or completeness. Opinions expressed are subject to change without notice and do not take into account the particular investment objectives, financial situation or needs of individual investors. Past performance is not indicative of future results. Employees of Janney Montgomery Scott LLC or its affiliates may, at times, release written or oral commentary, technical analysis or trading strategies that differ from the opinions expressed within.

Michael Halloran, CFA
Investment Strategist

Mr. Halloran serves as a Strategy Analyst in Janney’s Investment Strategy Group. Bringing over 15 years of financial service experience to Janney’s established team of professionals, Mr. Halloran analyzes all asset classes with particular emphasis on equity research.

Prior to Janney, Mr. Halloran was Vice President of Market Strategy for BPU Investment Management Group, and was responsible for the development of the firm’s global outlook and implementation of numerous investment strategies. His previous experience includes performing equity research for large cap core and growth mutual funds, and working in PNC’s investment banking organization supporting M&A, high yield, private placement, loan syndication and derivative security transactions. He is also an adjunct finance professor and former aerospace research engineer.

Mr. Halloran received his B.S. in Mechanical Engineering from the University of Pittsburgh, M.B.A. from Carnegie Mellon University and his M.S. in Mechanical Engineering from the University of Florida. He also holds the Chartered Financial Analyst (CFA) designation.

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