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The E in ESG: Why more investors are weighing environmental criteria in their portfolios

These days you hear a lot about "ESG investing" or "ESG screening" in relation to burgeoning interest in Responsible Investing. 'ESG' stands for environmental, social and governance, and represents a range of issues that can have an impact on a company's performance and on shareholder value, for better or for worse.

Many investors, including a significant portion of institutional money managers, are assessing companies' ESG performance, along with more traditional financial metrics, as part of their portfolio-building strategy. One recent report indicates that USD22.9 trillion of assets is being professionally managed under Responsible Investing strategies worldwide, an amount which represents 26% of all professionally managed assets globally.1 Those investors see good ESG performance as a strong reflection of superior management quality.

This is the first of a three-part series looking at each of the ESG components, starting with environmental considerations. We'll focus on social and governance considerations in future articles.

Protecting the planet and profits

When investors look at environmental criteria, they're interested in how a company performs as a steward of the natural environment, in their direct operations and across their supply chain. Climate change, rising pollution levels and depletion of natural resources such as fresh water and forests are major concerns in today's society, and those issues represent tangible risks (and opportunities) for many companies.

A growing body of evidence shows that companies that embrace sustainability perform better financially than those that don't. In 2014, CDP, a top climate research provider for investors, surveyed S&P 500 corporations to assess how well they were integrating climate change risk management into strategic planning, taking action towards emissions reductions and demonstrating a long-term view of how to best manage the assets of shareholders. The survey received a 70 per cent response rate. The analysis showed that the top-quartile performers generated superior profitability, with ROE (return on equity) 18 per cent higher than low-scoring peers, and 67 per cent higher than non-responders. The best-performing companies also showed significantly lower earnings volatility, and better dividend growth.2

Including or excluding companies based on environmental performance

Investors who pay attention to ESG performance use both positive and negative screens to exclude or include companies in their portfolios.

Negative screens can be used to rule out companies whose environmental policies and practices expose them to unacceptable levels of risk. Companies that don't take appropriate steps to curtail pollution or to avoid environmental accidents can face government or regulatory sanctions, criminal prosecution, and reputational damage that can harm shareholder value. Companies that fail to adequately plan for future impacts of climate change may be less profitable as a result.

Positive screens are used to find the top-performing companies, weighing factors such as reducing energy consumption and greenhouse gas emissions, reducing other forms of waste, protecting natural habitats and finding business opportunities to be part of the solution to environmental challenges.

Take the example of mining or oil and gas companies, which often use a lot of energy to run their operations and discharge environmentally harmful chemicals and pollutants. Some investors may choose to avoid these companies altogether. Others may choose to invest in the ones that demonstrate a serious commitment to reducing energy and water use, reclaiming land used for resource extraction, and taking steps to participate in the transition to a lower-carbon economy.

Environmental performance can be assessed in other sectors as well, including technology, financial services and retail. An example from the Canadian retail sector is Loblaw Companies, which ranks among Canada's top energy users because of its extensive retail network and trucking fleet. Loblaw has a strategy to reduce its carbon footprint 20 per cent by 2020 and 30 per cent by 2030.3 Its action plan is focused on energy-efficient stores and distribution centres, fuel-efficient transportation, and managing refrigerants and organic waste diversion. For example, Loblaw has converted a number of its open-bunker refrigeration units to closed-door units, which has helped to lower its greenhouse gas emissions and energy usage and in turn reduced costs.

Loblaw is one of the companies held in the Responsible Investment funds and portfolios of Qtrade Investor's sister company, OceanRock Investments Inc. OceanRock has over 15 years' experience assessing companies' ESG performance for its Meritas SRI Funds. It also works proactively with companies like Loblaw to encourage them to address ESG risks.

"What we see is that when companies deliver environmental returns, that's good for shareholder value," says OceanRock CEO Fred Pinto. "Companies that effectively manage and mitigate their environmental impact are more efficient and productive. Companies with strong environmental policies and practices are also less likely to face consequences that can negatively impact shareholder value."

Resources for investors

If you are interested in discovering companies that are deemed to be leaders when it comes to environmental performance here are a few resources to check out:

 

  1. Global Sustainable Investment Alliance. "2016 Global Sustainable Investment Review."
  2. CDP. "Climate action and profitability: CDP S&P 500 Climate Change Report 2014."
  3. Loblaw Companies Limited. "Loblaw pledges 30 per cent carbon reduction by 2030," December 14, 2016.

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