End of Week Notes
ESG is information
Plus Morningstar’s new framework, more on this year’s proxy season successes
ESG ratings are not simply a sorting mechanism by which companies are tossed into “good” or “bad” buckets. They are not meant to be the sole basis for an investment decision. They provide important information about how a company is handling material ESG challenges that asset managers may not have access to or don’t have a systematic framework for assessing.
Here’s what my colleague, Sustainalytics CEO Michael Jantzi, said about ESG ratings while he was in Chicago this week for the Morningstar Investment Conference:
It’s not meant to be a single indicator or a single tool to make a decision. It’s meant to be used alongside other tools and inputs to inform the user about whether or not this is a company you might want to consider investing in or engaging with. It’s a starting point to what lies beneath. There’s a lot of information there. We don’t attach a dollar value [to the risk rating or the analysis]. Our clients don’t want us to do that. That’s their job, as investment managers. They’re looking to us for social and environmental information, research they might not have access to, our insights.
Jantzi’s point was underscored at a conference panel on Thursday that included three successful managers of actively managed ESG funds: Karina Funk of Brown Advisory Sustainable Growth, Lance Garrison of Calvert Equity, and Stephen Libertore of TIAA-CREF Core Impact Bond.
All three funds are designated as medalists by Morningstar manager research analysts based on their overall process and performance, and as Advanced or Leaders based on their ESG commitment level.
All three managers emphasized the usefulness of ESG information and the importance of it to their strategies. Simply put, “ESG is more information,” Funk said. It helps them understand not only areas where companies need to improve but informs their discussions with management about sustainability. Asking managers with different roles about a firm’s sustainability challenges can be a productive way to get broader insight into a company’s direction, Funk said. Libertore agreed, noting that it often becomes obvious talking to a management team about sustainability issues who is more thoughtful and thinking long-term.
For all three, ESG ratings are a starting point, providing information about a company in an organized way that isn’t otherwise easy to obtain. From there, Libertore, the bond manager, focuses on how a company is adjusting its business model to meet its sustainability challenges in order to assure its long-term success. Garrison looks for companies that will benefit from sustainability trends. Funk buys companies whose growth is fueled by a sustainability catalyst that may lead to reduced costs, increased revenues, or enhanced franchise values.
In the end, all three have been successful using ESG ratings as information and embedding sustainability concerns into their decision-making, but — important to note — as part of a broader process that includes fundamental investing tenets, as well.
For example, according to Morningstar analyst Tony Thomas, at Calvert Equity, Garrison and his co-managers:
“favor profitable, competitively dominant firms with recurring — and growing — revenues and favorable industry conditions. They’re disciplined about valuations, looking for businesses trading at attractive levels based on earnings, cash flows, or private-market deals.”
At Brown Advisory Sustainable Growth, Funk and her co-manager focus on firms with historically higher earnings-per-share growth rates than the Russell 1000 Growth Index and durable competitive advantages.
For their part, Libertore and team use a fairly standard relative value approach alongside the ESG-based approach to evaluate companies and a unique focus of a significant portion of the portfolio on impact bonds.
I’ll give the last word to Brown’s Karina Funk:
“ESG is neither a silver bullet nor a bankrupt idea. Why wouldn’t you want to take into account all relevant information?”
Morningstar Sustainable Investing Framework
Also at the Morningstar Investment Conference this week we introduced the Morningstar Sustainable Investing Framework, which we think will help clarify terminology and overall understanding of the field, especially for advisors and individual investors.
The world of sustainable investing can be a confusing mix of terms and approaches. That’s mainly because of a lack of consensus over terminology and, perhaps more significantly, because sustainable investing does not represent a single, distinct investment approach. Rather, it consists of a range of approaches that have been evolving over the past decade, as asset managers and wealth managers adapted these approaches in unique ways to their existing investment processes. These developments have proceeded largely without regulatory guidance in most of the world, although regulators in the EU have taken some recent steps in the direction of clarifying terms and the scope of the field. As a result, investors have been left largely on their own to figure out the many facets of sustainable investing.
Morningstar’s Sustainable Investing Framework addresses the critical need for clarity in the field. It provides a straightforward way to understand investor motivations for seeking sustainable investments and outlines the range of activities associated with sustainable investing.
Here’s a schematic of the framework:
The Impact of Sustainable Investing: As You Sow reports on this year’s proxy season
I’ve noted in previous posts how successful this year’s proxy season was for sustainable investors. As You Sow, a non-profit that puts together networks of investors concerned about sustainability issues so it can file or co-file shareholder resolutions, has released its 2021Shareholder Impact Review, which further highlights this year’s proxy season success.
As You Sow led 188 engagements with 142 companies in 2021. Among the shareholder proposals it filed or co-filed, 48 were withdrawn because the target companies agreed to take the actions requested, 21 went to a vote, receiving average support of 43.3%, including 5 majority otes. A total of $1.67 trillion of share value was voted in favor of As You Sow resolutions.
Definitely worth the read:
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