Environmental, Social, and Governance (ESG) investing is one of the dominant investment topics over the past couple of years and we don’t see it slowing down. From the largest asset managers in the world (Blackrock) to the smallest firms, there has been an explosion in ESG investment vehicles and offerings. Socially Responsible Investing (SRI) is the forefather of ESG Investing. What once started as purely negative screens (no sin stocks!) has evolved into much deeper, robust, and nuanced space. Investors have plenty of investment options AND they generally do not need to pay higher fees nor potentially give up returns.
What is Environmental, Social, and Governance (ESG) Investing?
Environmental, Social, and Governance investing is also referred to as sustainable investing, responsible investing, impact investing, or socially responsible investing. ESG indicates the three central factors in measuring the sustainability and societal impact of an investment in a company or business. It is a way for investors to evaluate and find companies with values that match their own based on specific criteria. Environmental criteria may include a company’s energy use, waste, pollution, natural resource conservation, treatment of animals, and risk management. Social criteria look at the company’s business relationships. Governance criteria can refer to transparent accounting, stockholder voting opportunities, use of political contributions, avoiding conflicts of interest, and, of course, not engaging in illegal practices. No company will pass all tests in every category, so investors have the chance to prioritize factors most important to them.
Environmental, Social, and Governance (ESG)
The topic of ESG is often focused on equity investments – both public and private. We wanted to be sure clients and investors are aware this is also available in the fixed income space. This goes beyond just green bonds – issuances directly for climate and environmental projects. ESG principals can be applied when evaluating both corporate and municipal bonds. There does not have to be a sacrifice in credit quality nor performance.
Credit research is a key component of any fixed income manager and it is crucial to know the underlying financial strength of any issuer. How does ESG play a role? Let us look at the municipal bond space as an example. When evaluating an issuance, it must be known how the proceeds will be utilized. Will there be any specific or general societal good – if the proceeds lead to improved sustainability and decreased waste, this should ultimately strengthen the credit issuer. Municipal bonds often finance projects dedicated to infrastructure, health care, education, and environmental matters. These results should be measurable and part of the overall evaluation.
Environmental, Social, and Governance (ESG) Ratings
Naturally, challenges and issues remain. One example is the ESG rating system. Different rating services may provide varying ESG scores and if a bond manager has a proprietary ESG rating system their score could be different from the rating services. There needs to be greater consistency and agreement upon ESG principles. Further, investors need to look at sectors. As an example, there is a large alcoholic beverage company that scores very highly in ESG due to their governance and water conservation policies. However, their business is producing alcohol which may be a negative screen for investors. One final challenge – unfortunately, since the ESG space is gathering assets, there are a few bad actors that are claiming their bonds are ESG but couldn’t be further from the truth. Again, this goes back to credit research and due diligence.
Environmental, Social, and Governance (ESG) Manager Partnerships
Our preference is partnering with managers that were involved and advocated for the ESG space before it became “popular.” We utilize separate account managers, mutual funds, and exchange traded funds in the fixed income space. One of the advantages of separate accounts is the ability to customize. You can do both ESG and negative screens. For example, you or the organization you represent is anti-tobacco. It is relatively straightforward to exclude any tobacco bonds and have an ESG overlay. Our fixed income partners have delivered on ESG while maintaining similar credit and risk profiles without a sacrifice in total returns.
Whether you want to dabble in ESG or take a deep dive across your portfolio, CPWM has a full array of options and solutions. If you have questions or need further guidance on how to implement ESG investing, we are here to help.