One of Wall Street's newest strategies is to invest according to Environmental, Social and Governance issues, better known as ESG. It's a way to invest according to a certain ethical philosophy.
"Environmental, social and governance (ESG) criteria are a set of standards for a company’s operations that socially conscious investors use to screen potential investments. Environmental criteria consider how a company performs as a steward of nature. Social criteria examine how it manages relationships with employees, suppliers, customers, and the communities where it operates. Governance deals with a company’s leadership, executive pay, audits, internal controls, and shareholder rights," according to Investopedia.
A definitive list of ESG issues is hard to come by. This has led many to call ESG the updated version of Socially Responsible Investing, or SRI. They're similar because investors that follow these philosophies don't consider profit the only reason to invest in a company. These investors want to feel confident that they are investing in good corporate citizens.
Aware Asset Management incorporates ESG factors into our credit analysis and portfolio management because our conviction is that ESG factors can be important drivers of total return. We believe ESG consideration and portfolio outperformance should go hand in hand. Our objective as an investment manager is outperformance on a total return basis, when measured against our peers.
As an active fixed income manager, Aware believes that attention to material risk factors – including ESG -- is a critical step in credit selection. Our first criteria: is the company behaving responsibly regarding environmental, social and governance factors? We won't invest in companies that are not behaving responsibly, regardless of the yield offered.
In many industries, material ESG risk factors can easily be overlooked if analysis is solely focused on financial metrics. Thus, the Aware credit research team evaluates how corporate management addresses ESG related risks along with other risks in the quarterly and annual financial statements filed with Securities and Exchange Commission (SEC). In one-on-one interviews with management teams, we directly ask them how they're managing risks. Transparency in reporting and management's responsiveness to material ESG factors help us assess a company’s risk. And risk is a key factor in our decisions to buy, sell or hold a bond.
The first place to control ESG and other risks is through refining the universe for credit selection. We restrict our investments to dollar denominated, high quality companies that are typically not headquartered outside of North America, Europe, Japan and Australia, where companies are subject to robust regulations.
ESG factors can affect the performance and risk profile of fixed income investments such as utilities, energy, auto manufacturing, mining, insurance, and others. We invest in energy companies, but not just any energy company. We look for companies that have the infrastructure, technology and expertise to be leaders in renewable energy development. We invest in auto companies that are able to articulate how they’re positioned for a climate-focused future, such as through electric vehicles, more fuel-efficient engines, and lighter materials.
Our credit research team assesses which risks are satisfactorily addressed and whether the yield and credit spreads are sufficient to compensate for the risk.
A good example of a company Aware refused to invest in despite its considerable scale, potentially attractive yield and significant weighting in its benchmark index, is Vale. This Brazilian company is the largest producer of iron ore and nickel in the world.
Vale has a history of environmental destruction, not just from mining, but from its business practices. In 2015, a Brazilian iron ore tailings dam failed, killing 19 people and contaminating with toxic waste the soil, rivers and water system over an area of 528 miles.1
Our decision to not invest in the company's debt was reinforced earlier this year, when Vale failed to take proper safety measures at another Brazilian dam that ruptured. The burst dam killed 300 people and buried surrounding communities.2
It's clear that rating agencies have gotten the message from investors and other stakeholders that they value ESG factors when evaluating corporate behavior and investment opportunities. This has led rating agencies, such as Moody's, to become more focused on ESG factors in their analysis.
At Aware, we screen for a number of essential factors, including yield, credit quality, and related risks, such as ESG. If we are comfortable that we will be compensated for the risks, and we are equally confident that company management is acting responsibly toward the environment, human rights, and investors, we will proceed with the investment. If, on the other hand, we are not confident that the company is acting responsibly, and past behavior is as good a measure of this as any, we will not invest.
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It is not possible to invest directly in an index.
- Source: https://www.ohchr.org/en/NewsEvents/Pages/DisplayNews.aspx?NewsID=16803&LangID=E; and https://www.samarco.com/en/rompimento-de-fundao/.
- Source: https://uk.reuters.com/article/uk-vale-sa-disaster-ngo/ngos-push-to-expel-brazil-miner-vale-from-un-pact-over-dam-disaster-idUKKCN1Q12F6; and https://news.bloombergenvironment.com/environment-and-energy/iron-ore-giant-vale-faces-another-environmental-disaster-in-brazil