The evolution of investment in environmental, social and corporate governance. Here’s what’s next – News Couple
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The evolution of investment in environmental, social and corporate governance. Here’s what’s next


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The focus has been on sustainable investing where investors direct their money toward stocks based on so-called ESG factors, but shareholders will need to be involved to make a meaningful change in companies.

Sustainable US funds saw $15.7 billion in net inflows during the third quarter of 2021, according to Morningstar. Total assets in these funds were more than $330 billion as of September.

Screening stocks to ensure they meet ESG qualifications is just the start for investors who want to embrace sustainable investing. Look at activist funds with a focus on ESG to see how shareholders can hold boards accountable and create value for society – and investors.

Investing in ESG

Environmental, Social, and Governance (ESG) investing is when an investor uses a set of socially conscious criteria for a company’s operations to screen potential investments. Environmental standards take into account how the company performs as a servant of nature. Social norms look at how we manage relationships with employees, suppliers, customers, and communities. Governance deals with corporate leadership, board composition, alignment with stakeholders and stakeholder rights. The benefits of investing in an ESG cannot be overstated. It has dramatically changed the focus of investors and executives on thinking about things other than just returns and profits. It has led to more diversity on corporate boards and has allowed many retail investors the opportunity to make investments in line with their values. However, due to its negative nature, it has many shortcomings.

ESG قيود limitations

Its first limitation is that it uses quantitative examinations to identify the ESGs that appear to exhibit the most positive ESG behaviour. This is a problem for two reasons. First, quantitative examinations do not tell the whole story. For example, perhaps the biggest contribution the ESG movement has made is its impact on board diversity, but the quantitative process is far from perfect here. ESG funds are examined for companies with various boards of directors, but the analysis ends there. Diverse boards can still be well-established or uninvolved, and in a quantitative ESG analysis, a diverse board that is unengaged, rooted, conflicting, and self-acting will have the same rating as a diverse, cross-stakeholder board. One example that comes to mind is a technology company that was run by the founder’s husband-and-wife team with questionable material payments going to a company controlled by the founders’ family members. The Securities and Exchange Commission barred the wife from being an officer or director of a public company for five years due to an option delay. When the ban ended, she was reinstated as director and officer, and the company’s ESG rating was raised because they had added a woman to the board of directors.

The second limitation to investing in traditional ESG is that it is limited to screening best-in-class ESG companies and investing in those types of companies does little to create change. Passive investing in publicly traded securities of the leading ESG companies will not affect the environment or the social problems facing our world. For example, over the past 14 years, the dollars invested in ESG funds have increased significantly, but this has not only reduced the levels of carbon dioxide in the atmosphere, but the levels of carbon dioxide have increased significantly over the same time period.

AESG investment – this is the next step

Investing in ESG is still very recent and is likely to evolve over the next several generations. The first step was a change of mindset, and it’s clearly done and continues to happen. The next logical step is to change behaviors and this requires active investment in ESG, which is already happening. By active ESG investors we do not mean actively creating their portfolios or any investor that is not a purely passive ETF or index. These investors share the same problems as passive ETFs. They invest in the best ESG actors, not the ones that need to change. Active ESG (or AESG) investors are investors who actively engage with portfolio companies to bring about change to improve the environment, social aspects and/or governance. The real way to make a real difference in ESG is to invest with ESG investors who have someone on the board of directors.

An AESG investment will address two major problems with traditional ESG investing. First, it is a completely qualitative analysis of portfolio companies. It does not look at a diverse board and ends the analysis there. AESG funds an active and qualitative analysis of boards not only for diversity but for engaged, informed and experienced directors. All diverse boards are not equal in the world of AESG investing. Second, because it is an active and engaged strategy, it is not necessarily looking for the best ESG companies, but for any company where they can make positive change. These companies are often below average ESG companies. For example, investing in an oil and gas explorer and producer and actively persuading a company to convert its operations to renewables benefits the environment much more than passively investing in a publicly traded stock of a solar energy company. In other words, passive investing in ESG is about not being part of the problem while investing in AESG is about being part of the solution. Moreover, the process of changing a poor ESG company into a good one is not only more valuable to society than simply investing in good ESG companies, but it creates more value for shareholders as well.

AESG’s investment in action

There are already a few active ESG-focused funds, such as Impactive Capital, Inclusive Capital, and Engine #1. Similar funds create substantive improvements in ESG by engaging companies with negative or non-existent ESG characteristics and attempting to convert to positive ESG companies. For example, Engine No. 1 has secured three seats on Exxon’s board of directors through a proxy battle and is urging the company to increase its focus on renewable energy, zero emissions and clean energy infrastructure. Impactive Capital partners with Asbury Automotive, an auto retailer and repair company, and is hardly a beacon to ESG. But Impactive is working with them to make changes like adding maternity leave and women’s restrooms to get more women to work as machinists while solving labor shortage issues the industry faces. Inclusive Capital is active in wood pellet manufacturer Enviva, helping to convert coal plants into biomass and ensuring tree farms are managed responsibly. These are all companies that would never be included in the traditional ESG screen, but with activist participation and the ESG thesis, there is more opportunity here than the passive ESG companies that fill ESG portfolios today.

However, the biggest shift will come from activist funds that focused primarily on shareholder value and governance but are now beginning to tackle the “E” and the “S” as well, and in an active way. For example, Starboard Value has reconstituted Papa John’s board of directors with Starboard founder Jeffrey Smith becoming president. In addition to its successful economic and governance campaign, Starboard has removed a CEO who, according to a 2018 report in Forbes, created a hostile work environment for employees for years. Another example is Trian’s campaign at Proctor & Gamble where Nelson Peltz won a seat on the board. Trian mentioned to the company that they had spent significant resources on research and development and had not actually come up with new products. Peltz discovered a technique for eliminating plastic packaging that was more expensive but was worth it from an environmental perspective. done. Such funds have regularly held seats on corporate boards for many years and have had a significant impact on shareholder value and corporate governance. Now they are also starting to tackle environmental and social policies in companies and they are having an impact there too. We believe conscientious “G”-focused activists often do more for “E” and “S” than completely passive ESG investors, and we expect this philosophical change to be permanent and incremental.

Investing in ESG and Investing in AESG work together

Investment in global ESG funds has risen to over $1 trillion and continues to grow, as it should. Due to the ease of creating a passive ESG portfolio with quantitative metrics and ESG scores, a passive ESG will always receive the lion’s share of ESG assets. But if there is a real change in ESG, then AESG investment strategies should also get a portion of these assets. Since there are a limited number of investors who have the skill set, characteristics, and inclination to actively participate in managing portfolio companies, AESG investment strategies will almost always be a small subset of ESG’s total assets. But it will be an increasingly important subset, and those who are involved in AESG investing will add a much-needed active component to ESG investment. Furthermore, passive ESG funds and AESG funds are not exclusive and can have a symbiotic relationship. AESG investments will expand the world of potential ESG companies for passive ESG portfolio managers to invest in. These are the companies that have traditionally not been satisfied with ESG monitors but are now recognized as ESG companies because of the active ingredient to make a difference. To the extent that they are screened for trillions of dollars of passive ESG assets in the marketplace, passive ESG funds can now play a role in effecting change by investing in stocks of companies the AESG investor is in and supporting active activity. ESG investors in achieving their ESG goals.

Ken Squire is founder and president of 13D Monitor, an institutional research service on shareholder activity, and founder and portfolio manager of 13D Activist Fund, a mutual fund that invests in 13D’s active portfolio of investments.



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