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ESG: Keeping an eye on the governors

Steve Prostano
Family Wealth Advisors

This blog post is part of a year-long series that examines key concepts in our glossary of philanthropy services terms.

The acronym ESG stands for Environmental, Social, and Governance. It refers to a mode of screening investments that considers environment, social and corporate governance disciplines as criteria, seeking to achieve both competitive financial return and positive social impact.

View from hilltop with a few wind turbines, with other hilltops visible in the distance.ESG is part of the socially responsible investing (SRI) spectrum, and it is the most common portfolio screening that Family Wealth Advisors conducts.

ESG in action

Although most ESG screening is done by wealth managers themselves, Thomson Reuters provides structured and standardized ESG research in easy-to-navigate databases so that companies know where they stand and investors can feel secure that they are supporting companies with good practices. The Thomson Reuters database, for example, contains more than 6,000 global companies and over 400 metrics, according to its website. The Dow Jones Sustainability Index (DJSI) is also standard in the industry as third-party recognition of a company’s ESG performance, a Deloitte report on ESG notes.

ESG can be incorporated in many ways and can complement traditional quantitative techniques focused on analyzing financial risk. In fact, conducting a positive and negative screening of a portfolio, based on ESG factors, is typically the first step in the “purpose investing” process.

Conducting a negative screening of a portfolio involves identifying certain categories of investments that may be in conflict with the client’s values. Once this screening is done, clients may be surprised to learn that they hold controversial types of investments in their portfolios.

This type of screening may be used to exclude companies that have poor ESG records. For example, a car manufacturer could be removed from major ESG indexes if found to have cheated on emissions tests or committed other violations.

Conducting a positive screening of a portfolio involves requiring all holdings to meet certain requirements – for instance, actively seeking companies with strong ESG policies and procedures.

What are the potential benefits of ESG?

ESG directly impacts companies’ financial performance through risk to direct operations, supply chain, and products, and indirectly impacts it through “stakeholder actions along the entire value chain,” the Deloitte report on ESG found. Thus, for investors, knowing a company’s ESG record is part and parcel of confidently investing in companies that are strong and sustainable.

Investing in companies with a positive ESG reputation could be particularly important during times of economic uncertainty or social unrest, due to a potential shielding effect that Deloitte calls an “ESG halo.” For example, companies with strong ESG records were shielded from a decline in stock prices resulting from the 1999 World Trade Organization protests in Seattle, the Deloitte report explains.

Plus, just as with SRI overall, there is the benefit to investors that they are investing in companies that are governed well, with an eye for the environmental and social issues that they hold dear.

Investing involves risk, including the possible loss of principal and fluctuation in value. This information is for educational purposes only and is not intended to be investment advice or a recommendation to buy or sell a specific investment.

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