Investment

“ESG, Motherhood, and Apple Pie”? Seven ESG Policy Questions

“Motherhood and apple pie” is an idiom generally used to “represent things that most Americans consider to be very good and important.” Over time, different phrases like “the flag” and “baseball” have been appended to this phrase however none have actually caught. Now there may be one other contender: ESG.

Who would argue that nothing’s improper with firms that exhibit dangerous environmental, social, and governance (ESG) practices? Nobody!

However in investing, the reply isn’t so easy. Ought to buyers keep away from or interact with firms with low ESG scores? What are the professionals and cons of such approaches? Who ought to charge corporations on their ESG practices anyway? Is it even possible for all firms to be “good”?

These are among the many related questions buyers ought to contemplate when deciding the place they stand on ESG. Right here, we handle seven such questions to assist buyers devise the ESG coverage place that’s proper for them.

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1. Is there a efficiency penalty for ESG investing?

Skeptics imagine any ESG constraint reduces the universe of eligible securities, which might, by definition, incur a possible efficiency penalty. This argument has theoretical advantage. However at a sensible stage, there are vital offsetting elements:

  • There’s a optimistic relationship between ESG-type variables and company efficiency, in line with most empirical proof. A survey of 159 studies discovered that 63% present a optimistic relationship, 22% a impartial or combined relationship, and solely 15% a detrimental relationship.
  • Our research demonstrates that firms with robust long-term ESG monitor data barely outperformed the broad market benchmark, and high-ESG portfolios exhibited much less volatility than their low-ESG friends.
  • ESG information may also help facilitate higher choice making by enhancing assessments of firm high quality and worth.
  • ESG investing has vital momentum behind it that’s not prone to dissipate anytime quickly. To the extent this tailwind persists, it can have a optimistic self-fulfilling impact on ESG efficiency.

So a case might be made that issues about ESG investing incurring a efficiency penalty are overstated.

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2. Is ESG investing in line with fiduciary accountability?

Trustees have rightfully requested whether or not ESG concerns battle with fiduciary responsibility. Usually talking, trustees should base their selections on the perfect pursuits of their beneficiaries. This accountability is most clearly outlined for ERISA buyers however it applies to non-ERISA buyers too.

In the previous couple of years, the US and European governments have supplied steerage on ESG. The latter have constantly supported ESG investing, not solely endorsing the observe but in addition declaring that “not” contemplating ESG elements is inconsistent with fiduciary responsibility.

The US steerage has been extra ambivalent and displays the differing views of the 2 dominant political events. The Barack Obama administration permitted consideration of ESG elements as long as it was within the beneficiaries’ pursuits. The Donald Trump administration was extra skeptical of ESG elements. The takeaway is that ESG investing ought to stand by itself deserves with out governmental assist and should reveal that it may well generate aggressive returns.

As we’ve proven, proof means that ESG can meet these requirements and thus might be in line with fiduciary accountability. After all, that does not imply that ESG integration should be mandatory.

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3. Ought to firms be evaluated in opposition to their business friends or the broader universe?

There isn’t any consensus on what constitutes a great firm from an ESG perspective. Is an vitality agency robotically “dangerous” as a result of its merchandise pollute the surroundings? What if that firm has a concrete plan to shift to renewables? Is a nuclear utility good as a result of it isn’t a giant carbon polluter or dangerous due to the tail threat of a Fukushima-type catastrophe? Is Fb higher than Exxon due to its carbon neutrality pledge or worse due to its information privateness insurance policies?

A few of these questions merely replicate ESG’s rising pains as buyers come to grips with the associated dangers and alternatives. However others are extra basic and philosophical in nature and require upfront soul looking. Traders should resolve what ESG standards they may use to evaluate firms and whether or not to guage them relative to their business counterparts or to the broader universe.

An in-sector strategy offers helpful, apples-to-apples comparisons and eliminates the unattainable Fb-to-Exxon comparisons. However such approaches could not serve mission-oriented buyers who typically have exclusionary screens on sure industries. Many of those buyers could take collateral advantages past the returns ESG investments generate into consideration in making their selections.

All different buyers, particularly these ruled by ERISA, would discover this strategy unacceptable. Such buyers could be higher served by holistic methods that incorporate ESG elements as a part of the general funding course of.

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4. Is it logical to lump E, S, and G collectively?

Environmental elements are most related to solely a small cohort of firms, social elements have an effect on a broad swath of corporations, and governance elements have an effect on all.

The desk beneath presents sector-by-sector information for 3 widespread environmental elements for S&P 500 corporations. These sectors that compose greater than 10% of the whole universe are bolded.


ESG Components by Sector

Sector Vitality Used Water Used CO2 Emitted
Communication Providers 2% 0% 1%
Client Discretionary 5% 3% 3%
Client Staples 6% 1% 4%
Vitality 37% 3% 19%
Financials 0% 0% 0%
Well being Care 1% 0% 1%
Data Know-how 2% 0% 1%
Industrials 22% 0% 13%
Supplies 24% 7% 12%
Actual Property 1% 0% 1%
Utilities 1% 86% 44%

Supply: Excessive Pointe Capital Administration. Based mostly on uncooked information from Refinitiv Eikon. Underlying information are as reported by firms. These that don’t present the information are excluded from calculations for the aim of this exhibit. Based mostly on S&P 500 structure as of 30 November 2020.


The sector exposures to environmental elements differ extensively. Vitality, Industrials, Supplies, and Utilities account for 83% of vitality used, 96% of water used, and 88% of CO2 emitted. By market capitalization, these sectors represent solely 17% of the index.

In contrast, social and governance points don’t exhibit a lot sector differentiation. The desk beneath exhibits the related information for 2 social and two governance variables.


Social and Governance Components by Sector

Sector Gender Variety at Senior Ranges Cultural Variety at Board Degree Administrators Who Are Impartial Firms with Separate Chair and CEO Roles
Communication Providers 28% 14% 79% 62%
Client Discretionary 29% 9% 82% 66%
Client Staples 30% 16% 83% 77%
Vitality 20% 22% 85% 76%
Financials 30% 17% 85% 72%
Well being Care 29% 16% 85% 73%
Data Know-how 22% 16% 84% 55%
Industrials 23% 14% 86% 68%
Supplies 22% 17% 88% 61%
Actual Property 27% 14% 83% 65%
Utilities 23% 8% 89% 70%

Supply: Excessive Pointe Capital Administration. Based mostly on uncooked information from Refinitiv Eikon. Gender Variety relies on common proportion of feminine illustration at supervisor, government, and director ranges. Based mostly on S&P 500 holdings as of 30 November 2020.


There are two main implications from this information.

  • Score companies can distinguish themselves by customizing their information assortment by sector reasonably than taking a one-size-fits-all strategy. This may occasionally additionally earn them some goodwill from firms that might in any other case have to assemble and report information that’s not materials for his or her enterprise. Certainly, a German software company won a recent court case against a rating agency that had penalized the agency for not offering sure environmental information.
  • Any portfolio constructed round minimal environmental influence will probably have a lot completely different sector exposures than its benchmark. Social or governance-oriented portfolios, nonetheless, won’t diverge as a lot.
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5. Is it higher to boycott or interact with ESG-deficient firms?

Boycotting is straightforward, engagement is difficult. However the potential rewards of the latter are extra significant and direct.

We have documented that many ESG portfolios obese expertise and underweight “problematic” sectors like vitality. These portfolios have benefitted from robust tech efficiency and subpar vitality returns lately. However that pattern could not final ceaselessly and buyers have to be ready for a shift.

Energetic engagement past proxy voting might be not possible for small buyers, amongst others. However bigger buyers ought to get entangled to indicate their dedication to ESG.

6. What’s the position of the federal government and ranking companies?

Inconsistent steerage is worse than no steerage in any respect. So authorities ESG insurance policies shouldn’t change from one administration to a different.

ESG ranking companies are the self-appointed arbiters of ESG compliance. They’re assembly and, in some instances, creating their purchasers’ wants. Competitors amongst these entities will finally decide which requirements develop into the norm. Within the meantime, ESG raters can higher serve their purchasers by doing the next:

  • Rank firms by each their business peer group and the general universe so purchasers can select which ranking most closely fits their targets.
  • Discover a solution to scale back the large-cap bias inherent in ESG scores. This bias is brought on by the reliance on self-reporting. Giant corporations have extra sources to dedicate to those efforts and thus have a built-in benefit.

UN-PRI has been instrumental in selling ESG investing to counter local weather change. However its more and more complicated disclosure necessities endure from an analogous large-organization bias.

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7. Does historical past supply any steerage about ESG investing’s potential influence?

The fossil gasoline business has lengthy been a goal of activists and regulators. Its plight is harking back to the tobacco sector a number of many years in the past, Confronted with quite a few product legal responsibility lawsuits and rising taxes on their merchandise, tobacco firms needed to curtail their advertising and marketing efforts and demand fell.

However the business’s decline was a gradual one in the US. Tobacco was addictive and there have been no alternate options, so clients didn’t so simply break the behavior. And so they have been model loyal. Because of this, the sector had wonderful pricing energy, and tobacco firms have continued to generate prodigious money flows regardless of decrease unit gross sales.

Fossil gasoline firms lack related benefits: Their product is a commodity with little model loyalty. They’ve pricing energy solely when cyclical demand is excessive relative to provide. One issue of their favor: Their product is important, not discretionary like tobacco.

The fossil gasoline sector’s future depends upon how shortly renewables develop into price aggressive and dependable. The manufacturing prices of renewables are already aggressive. However the reliability of alternate options stays a difficulty. So buyers ought to maintain an in depth eye on it to gauge the vitality sector’s dangers and alternatives.

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“Motherhood and apple pie” is a virtue-signaling phrase and so is ESG. However ESG investing can and may stand by itself advantage. It doesn’t and shouldn’t want authorities assist.

A holistic integration of ESG information that doesn’t sacrifice returns stands the perfect probability of being accepted by fiduciaries. That’s the key to reaching widespread ESG adoption and to producing the best influence.

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All posts are the opinion of the creator. As such, they shouldn’t be construed as funding recommendation, nor do the opinions expressed essentially replicate the views of CFA Institute or the creator’s employer.

Picture credit score: ©Getty Photos / Malkovstock

Gautam Dhingra, PhD, CFA

Gautam Dhingra, PhD, CFA, is the founder and CEO of Excessive Pointe Capital Administration, LLC. He developed the agency’s pioneering funding strategy based mostly on the idea of Franchise High quality, and underneath his management, Excessive Pointe has constructed an enviable funding efficiency file. Dhingra served on the college member at Northwestern College’s Kellogg College of Administration for 2 years. On this position, he designed and taught The Enterprise of Investing course within the college’s MBA curriculum. His analysis pursuits embody ESG investing and valuation of intangible property. He holds a PhD in finance, with specialization in investments and econometrics, from the College of Florida’s Warrington School of Enterprise. At Warrington, he taught two programs in securities evaluation and derivatives.

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