Over the last month, many have asked themselves what they can do to help Ukrainians who are suffering, and many companies have stepped up beyond government sanction requirements. Some companies have stopped doing business in Russia, and some have raised money for humanitarian efforts. Many companies take a stand on not only political, but social issues as well, and generally try to do so in accordance with their mission. These decisions extend beyond our monetary votes as consumers and can evoke responses in investor actions as well.
Evaluating the virtue of a company prior to investing can be traced back to the 1700s. Quakers forbade their members to participate in the slave trade. John Wesley, one of the founders of Methodism, advised against investing in companies with poor working conditions for employees. In the 1990s this idea of avoiding “bad” companies took shape as socially responsible investing, when one avoided buying share in companies engaged in “sin” or “vice”. Examples such as tobacco companies, casinos, and gun manufacturers, oil companies or liquor manufacturers might be screened out of socially responsible portfolios.
Data management in recent years has made it possible to do more than just evaluate the company’s industry and products. We can now screen for many factors, both positive and negative, which can help guide investment decisions. This new approach is called environmental, social, and governance (ESG) investing, which suggests factors from those three categories may help (or hinder) a company’s ability to grow. Although it may seem “sin” has a history of profitability, “virtues” may have rewards of a different sort. High ESG companies may outgrow their peers because many investors are interested in feeling good about what they own, or because the companies represent the future, or because the ESG philosophy represents good business practices.
It is possible that companies with higher ESG scores are less likely to be disrupted by environmental problems, labor relations woes, or governance scandals, and as such may provide superior risk-adjusted returns. It is not possible to know for certain, but investors may wish to consider ESG factors beyond their moral implications. These new ESG factors have already started impacting how investors, some Exchange Traded Funds (ETFs), and Mutual Funds choose companies, and that impact is likely to grow. Here are a few factors from each category:
Concerns about the environment may include:
- Climate change policies, plans, and disclosures
- Greenhouse gas emissions goals
- Carbon footprint and carbon intensity
- Water-related issues and goals, such as usage, conservation, overfishing, and waste disposal
- Green products, technologies, and infrastructure
Social concerns may include:
- Employee treatment, pay, benefits, and perks
- Employee safety policies, including sexual harassment prevention
- Diversity and inclusion in hiring, in advancement opportunities, and in raises
- Ethical supply chain sourcing, such as conflict-free minerals and responsibly sourced food and coffee
- Public stance on social justice issues, as well as lobbying efforts
Governance may cover such areas as:
- Whether executives are entitled to golden parachutes (huge bonuses upon exit)
- Diversity of the board of directors and management team
- Whether chairman and CEO roles are separate
- Dual- or multiple-class stock structures
- Transparency in communicating with shareholders, and history of lawsuits brought by shareholders
Much more information on ESG investing is available from the SEC. For example, here is an overview of ESG issues, and here is more specific information to consider when investing in mutual funds and EFTs with an ESG element.
Companies can provide scores for ESG reporting. However, one difficulty is scoring is not necessarily universally understood. Some companies may score extremely well in certain categories while scoring poorly in others. This might result in a relatively high overall ESG score, with failing marks in the category that aligns with a particular investor’s goals and sensibilities. For example, an oil company may have a low environmental score but have great working conditions and a diverse board of directors.
At Arvest Wealth Management, we build portfolios for each client and their family based on their sensibilities and situation. It is a process of understanding your values, your time horizon, your need for risk mitigation, and participating in your wealth journey by providing information for you to be able to make informed decisions. If you are interested in learning more about these ESG factors or the fundamentals underlying your investments, schedule a meeting with one of our client advisors.
This content has been prepared by The Merrill Anderson Company and is intended as a general guideline.
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