News on ESG and Sustainability

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August 23, 2018

Are Investors Right to Consider ESG Risks?

Ted Knutson writes in Forbes:

       Investors are right to consider environmental, social and governance (ESG) risks because they can impact the worth of intangible assets which make up more than 80 percent of company value, said a new report by the Society for Corporate Governance.

        The intangible assets that could be subject to ESG concerns include brand names, reputation, top managers, technological know how and a loyal, well-trained and engaged workforce said the study by the professional association for internal corporate governance workers and external consultants.

Matt Turner of compensation consultant Pearl Meyer wrote about the inclusion of ESG factors in incentive compensation:

[I]n various ways, ESG issues are showing up in the performance framework of executive incentive compensation and, more broadly, in executive performance evaluation.  With respect to incentive plans, ESG issues may show up as modifiers to the overall funding of executive cash incentives.  Alternatively, if the specific issue can be attributed to key individuals, or component metrics of the overall goal can be identified, they may show up in the individual performance portion of an incentive plan. . . . Typically such metrics are given only modest weight in the overall incentive funding formula – something along the lines of 10-20% of the total.  The modest weighting may be due to the amount of practical control and influence an executive team may have over the goal.  Somewhat related, objective measurement of progress or success may be difficult, requiring subjective judgment.  While the actual weight may be modest, the important thing is the signal being sent both to the executive team and the external stakeholder community about the importance of the issue.

Does Sustainable Investing Lead to Lower Returns?

A special issue of Barron’s on ESG is itself a significant indicator that ESG has entered the mainstream of securities analysis. The issue’s articles are exceptionally thoughtful and well worth reading in detail. An excerpt:

        Here’s what ESG integration is really about: From an investor’s standpoint, a sustainable company is one positioned for long-term success, one whose management understands and addresses short-term risks and innovates to exploit long-term opportunities.  ESG data are a means that can enable an investor to understand a company’s strategy, corporate purpose, and management quality, at scale and in an unbiased, quantifiable way.

        ESG is about understanding how companies are adapting to transformational change, such as the shift to a low-carbon economy.  European electric utility companies, such as RWE, missed the message that renewables should become an important part of power generation.  They lost half a trillion in market capitalization as a result.  Automobile manufacturers are in a race to not become the next victims by missing the electrification wave.  Consumer packaged-goods companies, such as General Mills, Nestlé, and PepsiCo, are product reformulating as consumer preferences change, taking out sugar and sodium from their products, while repositioning their offerings to compete in healthier food and beverage choices.

            It is also about understanding how and which technology companies are best at managing data-privacy issues.  In the wake of the Facebook controversy, not only shares of Facebook, but also those of Twitter, which is also highly exposed to data-privacy issues, dropped more than 10% in a day.  It is about how retailers are managing a more productive workforce. As Walmart discovered, moving away from its legacy of poor labor relations, improving workplace conditions, and creating economic opportunity for its associates can improve employee engagement, leading to higher customer satisfaction and higher revenue growth.

Morgan Stanley’s Sustainable Signals Report

The report finds that asset managers are increasingly relying on sustainability indicators:

        The survey polled 118 public and corporate pensions, endowments, foundations, sovereign wealth entities, insurance companies and other large asset owners worldwide and gathered insights about trends, motivations, challenges and implementation approaches in sustainable investing.  By rounding out the sustainable investing landscape with the views of asset owners, this work builds on our previous Sustainable Signals studies focused on individual investors and asset managers.

They found that 84% of asset managers are pursuing or considering pursuing ESG integration in their investment process – 60% of those began doing so in the last four years and 78% seek to align with the U.N. Sustainable Development Goals.

BlackRock’s New White Paper Is Called the Investment Stewardship Ecosystem

It opens with a quote from Larry Fink’s earlier letter to CEOs:

        “Your company’s strategy must articulate a path to achieve financial performance.  To sustain that performance, however, you must also understand the societal impact of your business as well as the ways that broad, structural trends – from slow wage growth to rising automation to climate change – affect your potential for growth.”

And it puts this sentence in bold: “Our mission is to create a better financial future for our clients and our number one focus is on generating long-term sustainable performance.”

Starbucks Ditches Straws

Starbucks Corporation agreed to eliminate plastic straws following a shareholder proposal from As You Sow, which got a 30% vote in favor.

Cambridge University Addresses Climate Change

Cambridge University has made a landmark commitment to addressing climate change in its £3 billion ($3.9 billion) endowment fund following months of pressure from students and staff.

Hermes Investment Management Invests in Carbon Tool

Hermes Investment Management has been investing in the development of a number of ESG tools for its fund managers and engagers to use to make enhanced investment decisions and to better inform engagement activities with companies on ESG matters.  Hermes will be launching a carbon tool that allows fund managers to assess their fund’s carbon performance, carbon risk, and corresponding engagements with investee companies in a comprehensive manner. The tool will also be the source for enhanced client reporting to demonstrate how ESG and engagement is being credibly integrated into the firm’s fund and stewardship offerings.

Be Aware of False ESG Disclosures

Harry Broadman writes in Forbes that investors should be alert to false ESG disclosures that may be hiding bribes to foreign officials:

        One of the most well-known examples of such malfeasance dates back to 2011 when two oil companies contributed an initial installment of $175 million (out of a promised total of $350 million) to establish a technical research and training center in Angola to be run by that country’s state owned oil monopoly – Sonangol.  More than six years later there is no such center and no one seems to know where the money actually went.

New ESG Fund Makes Promises

Felix Salmon writes in Slate about a new ESG fund with some big names and promising prospects:

The product in question is called the JUST U.S. Large Cap Equity ETF, it trades under the ticker symbol JUST, and it’s being brought to you by Goldman Sachs in association with Just Capital, a nonprofit organization founded by billionaire hedge fund manager Paul Tudor Jones. Just Capital’s raison d’être is to rank America’s companies, and then to make those rankings public so that everybody has the ability to act on them, in terms of who they buy from, who they work for, and – yes – who they invest in.

       The names here – not only Goldman and Tudor Jones, but also Just Capital’s board members, who include Deepak Chopra and Arianna Huffington – seem almost designed to elicit eye-rolling and snark. But after you take a look at the Just website and its detailed methodology, it turns out that the JUST ETF and the Just 500, as the underlying index is known, are smart, well-constructed products that give the investing public something important and valuable.

The European Bank of Reconstruction and Development Will Share Its Climate-Related Financial Information in Its Investments for the First Time This Year

In its Sustainability Report, it writes:

        We pride ourselves on measuring and reporting on our impact transparently and in an accountable way.  This report contains data on health and safety, greenhouse gases, and various other aspects of our project monitoring.

DOL Warns Pension Fiduciaries that Economic Concerns Should Not Be Compromised by ESG

A new Field Assistance Bulletin issued on April 23, 2018 by the U.S. Department of Labor, which has jurisdiction over ERISA funds, provides:

        In IB 2015-01, the Department reiterated its longstanding view that, because every investment necessarily causes a plan to forego other investment opportunities, plan fiduciaries are not permitted to sacrifice investment return or take on additional investment risk as a means of using plan investments to promote collateral social policy goals.  IB 2015-01 also reiterated the view that when competing investments serve the plan’s economic interests equally well, plan fiduciaries can use such collateral considerations as tie-breakers for an investment choice.  The preamble of IB 2015-01 added: “if a fiduciary prudently determines that an investment is appropriate based solely on economic considerations, including those that may derive from environmental, social and governance [(ESG)] factors, the fiduciary may make the investment without regard to any collateral benefits the investment may also promote.”

            In making that observation, the Department merely recognized that there could be instances when otherwise collateral ESG issues present material business risk or opportunities to companies that company officers and directors need to manage as part of the company’s business plan and that qualified investment professionals would treat as economic considerations under generally accepted investment theories.  In such situations, these ordinarily collateral issues are themselves appropriate economic considerations, and thus should be considered by a prudent fiduciary along with other relevant economic factors to evaluate the risk and return profiles of alternative investments.  In other words, in these instances, the factors are more than mere tie-breakers. To the extent ESG factors, in fact, involve business risks or opportunities that are properly treated as economic considerations themselves in evaluating alternative investments, the weight given to those factors should also be appropriate to the relative level of risk and return involved compared to other relevant economic factors.

        Fiduciaries must not too readily treat ESG factors as economically relevant to the particular investment choices at issue when making a decision.  It does not ineluctably follow from the fact that an investment promotes ESG factors, or that it arguably promotes positive general market trends or industry growth, that the investment is a prudent choice for retirement or other investors.  Rather, ERISA fiduciaries must always put first the economic interests of the plan in providing retirement benefits.  A fiduciary’s evaluation of the economics of an investment should be focused on financial factors that have a material effect on the return and risk of an investment based on appropriate investment horizons consistent with the plan’s articulated funding and investment objectives.

Guns Become a Significant ESG Issue

In the United States, citizens, shareholders, consumers and corporations have made guns an important priority.  ValueEdge Advisors Vice Chair Nell Minow was quoted in the Los Angeles Times about shareholder pressure to improve gun safety:

        The effort by Dick’s and other private firms is not unlike earlier, concerted investor campaigns against tobacco companies and apartheid in South Africa, in which “people were taking those stocks out of their portfolios and putting pressure on companies,” said Nell Minow, vice chairwoman of ValueEdge Advisors, which promotes strong corporate governance.

        “Investors were on it before the states’ attorneys general and the regulators were on it,” she said.  In the gun-control movement, too, the private sector “is a leading indicator that the mood of the country is changing,” Minow said.

NOTE: ISS and Glass-Lewis both recommended votes in favor of a proxy proposal calling for a report on gun safety.  The shareholder proposal was filed by the Sisters of the Holy Names of Jesus and Mary in Oregon.  It asks Sturm Ruger & Co. to report on gun safety such as how it monitors violence, research on safer guns, and its assessment of risks to its reputation.  Reuters reports:

Proxy adviser Institutional Shareholder Services on Wednesday recommended investors vote to support a shareholder proposal calling for gun maker Sturm Ruger & Co to report on gun safety, which could put new attention on so-called “smart gun” technology.

                  *      *      *         

        The board of Connecticut company Sturm Ruger had recommended investors vote against the call for the safety report.  Its proxy statement said that “the intentional criminal misuse of firearms is beyond our control.  Similarly, the constitutional right of firearms ownership carries with it certain responsibilities and the Company has long advocated the safe and responsible ownership and use of firearms.”

oekom Sees Progress in Social Responsibility/ESG

oekom research (now a part of ISS) is a rating agency focusing on sustainable investment. Their Corporate Responsibility Review 2018 report confirms the upward trend observed over the past five years.  The share of companies in industrialized countries with good and very good ratings is currently 17.19% – slightly higher than in the previous year.  Moreover, at 43.62%, the group of companies with a medium sustainability performance is larger than the proportion of companies with inadequate sustainability performance for the first time.  The percentage of companies with inadequate sustainability practices is down to 39.19%, the lowest level to date.  However, there is a comparable trend that can be observed among companies in emerging markets at a lower level.

Is Facebook a “Sin Stock” for ESG Investors?

As the powerhouse digital “FANG” stocks (Facebook, Amazon, Netflix, Google) all took a dip in stock price, how much of the dip was in response to concerns over government action?  An article in Bloomberg suggests that ESG investors may want to divest for reasons of principle as well as liability or regulatory concerns:

        Just how toxic is the data-privacy scandal for Facebook Inc.?

        So toxic that some investment funds now are lumping in the social network with big polluters and other corporations they consider ethically challenged.

Sustainability Reporting Reaches “Supermajority” Status

Bloomberg Law reports:

        Eighty-five percent of the nation’s largest public companies reported on climate change, diversity, and other sustainability issues in 2017, according to a March 20 study from the Governance & Accountability Institute.

        Sustainability reporting by companies in the S&P 500 index hit a majority for the first time in 2012 and has climbed steadily since then, the institute’s annual analysis shows.  Its chairman and co-founder Hank Boerner called this year’s result a “super-majority.”

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