There are several different ways to incorporate ESG into your portfolio, because ESG investing isn’t a one-size-fits-all approach.
ESG investing involves using a company’s environmental, social, and governance data to guide investing decisions. But a lot of information falls into those three buckets, and which data points to focus on and how to use that data may vary from investor to investor.
On top of that, different investors may have different reasons they’re using ESG. Maybe they hope to use ESG as a form of risk management, by looking for long-term business viability and avoiding businesses that may face regulatory liabilities. Or maybe they want to use ESG to invest in companies that align with their personal values.
One of the popular ways investors incorporate ESG data into their portfolios is through ESG screening, which involves including or excluding companies based on their ESG performance. However, this approach differs from a technique many impact investment funds do — active ownership.
Let’s examine these two different ESG investing approaches to better understand the pros and cons of each.
ESG screening comes in two different forms — positive screening and negative screening. Both approaches are relatively straightforward. Positive screening involves investing in companies based on certain ESG factors, while negative screening involves excluding companies from your portfolio or divesting.
Positive and negative screening are really just two sides of the same coin, and can be done in tandem. In order to incorporate screening into your portfolio, all you need is relevant ESG data and a personal strategy of what you want to invest in or avoid.
For example, if you want to construct a portfolio of women-led businesses, you need access to the gender breakdown of a company’s board of directors or leadership team. That way you can positively screen women-led companies into your portfolio. If you see that some of the companies already in your portfolio have no women in leadership positions, then you may want to negatively screen them out.
Provided that you have the proper ESG data, it’s relatively easy to incorporate ESG into your portfolio this way.
Screening can help investors who are using ESG from a risk management perspective. If they believe the global transition to renewable energy will benefit green energy companies and hurt traditional fossil fuel companies, they can use ESG screening to make sure their portfolio aligns with that hypothesis.
Screening can also help investors who want to make sure their investments are aligned with their personal values. This sort of investing happens all the time, whether it’s universities divesting from oil companies after student pressure, protesters divesting from napalm manufacturers during the Vietnam War, or religious investors divesting from “sinful” industries like gambling or drug use.
Screening is popular in values-based investing and ethical investing, which have both been around for a long time. But what if you’re an impact investor who wants to use their investment to promote some sort of change? Sure, positive screening may help promote the companies you do invest in, but negative screening can leave you out of the conversation for the companies you may want to change, which could create an echo chamber effect. That’s why some impact investors are turning to a more hands-on approach known as active ownership (or active engagement).
Active ownership involves using one’s position as a shareholder to push a company towards positive change. This can be done through things like shareholder voting, attending annual shareholder meetings, putting forward shareholder proposals, and so on.
A famous example of active ownership at work is Engine No. 1’s board takeover of ExxonMobil. In 2020, Engine No. 1, a relatively unknown activist hedge fund, acquired a small stake in the oil giant ExxonMobil. Although Engine No. 1’s shares only represented about 0.02% of the company, the hedge fund was able to use its shareholder status to put forward a handful of shareholder proposals and nominate new members to Exxon’s board of directors. After getting support from large asset managers like BlackRock, Vanguard, and State Street, Engine No. 1 was able to win three of Exxon’s board seats.
Why did Engine No. 1 care about winning board seats? The hedge fund had three main goals: to bring independent directors with energy experience to Exxon’s board, to promote better long-term capital allocation, and to implement a strategic plan for Exxon’s business in a world that is rapidly moving towards sustainability and decarbonization.
Since Engine No. 1’s board takeover, Exxon has made several commitments to lowering its greenhouse gas emissions and invested billions of dollars into low carbon solutions.
Okay, so all you have to do to implement active ownership into your portfolio is target a multinational company, wage a months-long shareholder campaign, and get some of the largest asset managers in the world to support your cause? Well, not exactly.
Screening may seem easy to incorporate into your portfolio because it just involves including or excluding companies based on ESG data. Active ownership may take a little bit more work, but it could be as simple as using your shares to vote.
"If you're a shareholder of a company, you should be active. Active ownership is really important,” Yusuf George, Managing Director of Engine No. 1, said at a recent SOCAP event.
“Part of the reason [Engine No. 1] talks so much about the energy sector, the transportation sector, and agriculture is because they account for about 75% of greenhouse gas emissions. We want to go where the problems are, because if we don't, nothing will change. And so we believe that it's really important to use any tool you have — it can be voting your shares, showing up at an annual general meeting, whatever tool you have to be an active owner is really important."
As Yusuf George points out, leaning into the problem is important because it could help lead to change. While exclusionary screening may work for a risk management approach, active ownership may lead to a greater impact on the company.
If your goal as an investor is to have an impact, then it could be worth it to use ESG data to identify opportunities for impact within a company. Then you could use your position as a shareholder to push for change with whatever tools you have — whether that’s voting, putting forward proposals, or just spreading awareness of issues.
Responsible investing incorporates Environmental Social Governance (ESG) factors that may affect exposure to issuers, sectors, industries, limiting the type and number of investment opportunities available, which could result in excluding investments that perform well.
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The views expressed are those of the author at the time of writing, are not necessarily those of the firm as a whole and may be subject to change. The information contained in this advertisement is for informational purposes and should not be regarded as an offer to sell or a solicitation of an offer to buy any. It does not constitute a recommendation or consider the particular investment objectives, financial conditions, or needs of specific investors. Investing involves risk, including the loss of principal. Past performance is not indicative or a guarantee of future performance. We do not provide tax, accounting, or legal advice to our clients, and all investors are advised to consult with their tax, accounting, or legal advisers regarding any potential investment. The information and any opinions contained in this advertisement have been obtained from sources that we consider reliable, but we do not represent such information and opinions are accurate or complete, and thus should not be relied upon as such. This is particularly true during periods of rapidly changing market conditions. Securities offered through Fennel Financials, LLC. Member FINRA SIPC.
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