It’s been a year since we announced our plan to integrate environmental, social and governance factors (ESG) into our investment processes,, across our entire existing product suite. A lot has happened since then, and we’ve learned a lot along the way. The five big lessons and challenges can be summed up as:
1. Start with a well-established mindset and vision
2. Build a framework
3. Corporate transparency really matters, but is imperfect
4. Build credibility, then interject
5. Put ESG into action
With the weather starting to cool down and leaves changing colour, this back-to-school feeling has me reminiscent of the work we’ve done with ESG and the key learnings.
Thinking back to our first looks at our funds from an ESG perspective, it’s interesting to reflect on what that was like. We had a clear idea of what we wanted to do, but actual integration isn’t just straight-forward.
Now that I look back, there were five key lessons and challenges based on what we carried into the early days of implementation and what we learned:
1. Have a Vision
We were guided by the widely proven view that with proper implementation, ESG integration should be expected to enhance a portfolio’s returns. We also had firm high-level ideas of what we wanted to do:
- Improve the sustainability of our portfolios, as measured through an ESG lens
- Pursue integration over exclusion
- Be pragmatic rather than dogmatic
- Recognize that every mandate is different and requires a different approach
But even that vision had some controversy. We discussed it amongst ourselves constantly, drawing on views from members across our entire organization.
I even debated my colleague Josh in front of the whole company during a townhall lunch about whether ESG was a fad. It was a heated battle and there was a healthy amount of skepticism.
However, with an idea of what we wanted to do, we established an internal working group and subscribed to a third-party specialist vendor to get access to the data, insight and analysis we would need to begin incorporating this new dimension into our various processes. The journey had truly begun as we moved from idea to action.
2. Build a Framework
When we first dove into our portfolios, it immediately became clear that there was going to be no easy formula for implementation. Successful quantitative ESG integration would be a massively complex data science exercise beyond the scope of our allocated resources.
With a broad lens, there is a ton of nuance in the data, and apples-to-apples comparisons can be few and far between.
Despite having access to a ton of data, we would need to start out the old-fashioned way by establishing a basic framework and manually diving into industry and company reports. Several basic questions emerged:
- What measure should we use to flag a security? Absolute risk rating? Industry-relative scoring? Controversies?
- Do we agree with the analyst’s perspective on risk exposure, management and materiality?
- What is the appropriate threshold to flag with a portfolio manager?
- What will our process be to collectively re-analyze the security and respond with a sell, reduce or hold decision?
Analyst perspective and data don’t come with a manual on how to incorporate it into an investment process, each of which is different and may require a different approach.
3. Corporate Transparency is Imperfect
Another complication that comes to light is how often a negative ESG risk score can come from a lack of disclosure rather than an offensive action or policy. There is logic to this, but it’s still a bit dissatisfying considering the principal of innocence until proven guilty. It’s hard to judge what you don’t know, especially in the early days.
Thankfully, the positive feedback loop between the mechanics of these scoring systems, broad ESG adoption, equity valuations and incentives around corporate transparency will solve for this, particularly as time goes on. More interest in ESG will force companies to be more transparent, giving us better data to make decisions.
4. Raising Red Flags with Credibility
Despite these and other challenges, we emerged from the initial looks with a dramatically improved understanding of the material but non-financial risks across our portfolios.
It was the beginnings of the framework for how we would incorporate this new knowledge into our traditional valuation tools.
This gave us the confidence we needed to raise flags with our individual portfolio managers, ask the tough questions and work collaboratively toward solutions. Convincing a PM wasn’t always easy, but as we worked together, learned together and better understood the deep, inherent value of ESG analysis, it started to take off. To have the credibility to interject, you need to do your homework and have a clear articulation of why your ESG perspective matters for each specific investment.
5. Walking the Talk
Now it was time for the hard part. We were off and running. We found companies that looked attractive on traditional reports but had underlying issues not found in financial documents. And we started to debate and reduce our exposure to those companies as appropriate.
We even had a sell order executed during our first ESG Committee Meeting based on new information that came to light about a smaller fund holding.
This is admittedly anecdotal, but it does highlight how quickly a new dimension can cause you to change your perspective on the attractiveness of a holding. That is a material development!
Now, as I sit down to write this, we’re at the end of the third quarter in 2020. What we’ve learned is that this is an evolutionary process. We have more to share and we will continue to diarize. We hope you will read on and follow us on our journey toward making Purpose’s portfolios more sustainable and more robust.
— Graeme Cooper is Vice President of Product at Purpose Investments
All data sourced from Bloomberg unless otherwise noted.
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