“It is difficult to get a man to understand something, when his salary depends on his not understanding it.”
                                    -Upton Sinclair

Over the years I’ve had many clients ask about what used to be called Socially Conscientious investing. This term encompasses many different things; in fact it started with investments recommended by religious organizations to insure you were only putting your money into companies that had “Catholic Values” or “Lutheran Values” for example. More recently, this concept has come to be equated with the avoidance of companies or industries with poor environmental records. This traditional type of Socially Conscientious investing, since entire industries were excluded, had portfolios that were not well diversified and suffered from the poor risk adjusted performance you would expect from avoiding whole swaths of the economy. In our experience most clients who insisted on this type of investing would choose to meet their financial goals and abandon these narrow investments, perhaps donating a little more to charity to make up for it. But over the past fifteen years or so a much better method of achieving many of these same goals has emerged; it’s called ESG investing, where those initials stand for Environment, Social and Governance. I want to use this month’s article to introduce many of you to ESG investing and why we feel it could be a viable investment option for those who want to prioritize using their investment dollars to help make social change.

First I want to further define the E.S.and G in ESG. Environment is the easiest to understand, having an “E” screen on your investments would steer you toward companies that use green building materials, sustainable forms of energy such as wind and solar, and simply have a lower carbon footprint than their industry counterparts (maybe prioritizing teleconferences over flying management around the country for example.) The “S” as mentioned stands for Social. Companies with good Social scores would have positive workplace safety records, have non-discriminatory employee benefit offerings, have a good record of equal pay between male and female employees, have a positive impact on the communities in which their companies operate, and take sexual harassment reporting seriously. The “G” does not stand for Government, but Governance – the way in which these companies govern themselves. This category favors companies that have reasonable executive compensation, no golden parachutes for management, stock option and bonus plans that operate the same way for executives as for other employees – and most importantly emphasize Boards of Directors that are diverse and independent. 

ESG investing started with large Endowments, Foundations and Pension funds that had mandates that would have steered them toward the traditional Socially Conscientious investments, but managers that objected to the lack of performance they were seeing in those options. The problem with simply avoiding all oil companies for example is that those companies have not idea you are avoiding them, and if your mandate doesn’t allow you to invest in oil companies at all, under any circumstance, then what incentive does an oil company have (monetary incentive that is) to get any better? If instead there was a method of investing that allowed you to invest in some oil companies, the ones that were spending money researching carbon capture technology and investing profits in solar and wind arrays, while avoiding the companies that are instead using their profits to fight environmental legislation – wouldn’t that give you a seat at the table? Wouldn’t that give the “cleaner” oil company an incentive to keep getting cleaner?  As for the other factors, wouldn’t a company that knows it’s only getting investment money from a Pension Fund or a Charitable Foundation because they (the company) have a great workplace safety record, extend employee benefits to same sex partners and have significant female representation on their Board of Directors be more likely to stick to doing those things rather than abandon them for some short-term reason? The information these early adopters needed to make these decisions wasn’t readily available when the mandates were put into place in the 1990’s and getting that information was expensive and time consuming. Starting in around 2005, the data bases built up by the early adopters as well as increased reporting requirements by regulators made this information easier and cheaper to obtain, and that pace has continued as more retail investors starting stepping into this ESG world. As this type of investing has grown, its ability to put pressure on companies to either keep progressing or to change their practices has grown along with it.  As of 2016 almost 20% of all managed investment dollars in the United States came with an ESG mandate – that amounts to over $8 Trillion dollars that companies who don’t meet these ESG standards cannot get access to – regardless of what their quarterly earnings might have been. Having 20% of your investors required to sell your stock if you are found to be lacking in one of these mandated areas is a tremendously strong monetary incentive to keep improving. This is why this is often called Impact Investing.

So why is Keeling Financial just talking about this now if it’s been around for so long? We have always felt that our first priority is to help our clients achieve their financial goals. With the impact of the Great Recession in 2008 to the anemic economic recovery from the same, to the rising costs of health care and housing, most of our clients have sufficient assets to meet their goals but not if they suffer years of under performance. Of course, the future is unknown and any assumptions we make about future investment returns are based on past results and are thus not set in stone, but at least with traditional portfolios we have years of those past results to look to – giving us a little comfort in our projections. With ESG investing, the time frame is much shorter. The internal costs of ESG investing, as mentioned, used to be high. So even if we had evidence of similar gross performance, especially high fees could have taken the net performance our clients experience into unacceptable territory – but the recent drop in those costs has brought the fees for ESG portfolios into the same general range of traditional investments. As for that gross performance number, anecdotally it seems like ESG portfolios should have some performance advantages. We’ve all seen companies over the last few decades have their profits and reputations tarnished by environmental disasters, worker safety problems, sexual harassment accusations and rubber stamp Boards of Directors. (I can give you more than one company name for each of these issues.) Regulatory Fines, Class-action lawsuit payments, consumer boycotts and simple bad corporate management are the results of these issues, and while ESG investing can’t eliminate all the risks associated with these things as the reporting isn’t perfect – they can significantly lower the chances you end up owning companies with these risk exposures. Now that we have almost twenty years of actual investment results we see some evidence that these portfolios at least track with the results of more traditional portfolios. For example; Morgan Stanley Capital International (MSCI) the company that created the most widely tracked international stock index, put together a research group looking into ESG investing, called uncreatively, MSCI ESG Research, LLC. They published a study in 2017 titled:  Foundations of ESG investing, How ESG affects Equity Valuation, Risk and Performance.  This study showed that high-sustainability investments are typically worth more and grow at a faster rate than low-sustainability investments. In fact the investment group at Northern Trust, who I visited back in October, has even started to wonder if ESG is a market factor, like Value or Small Caps that shows a long-term out performance. I am not willing to go that far, after all the Value factor can be tracked back to 1927 while at best we’re getting twenty years of ESG data – but I’m at least convinced that our clients won’t harm their chances of meeting their long-term goals if they were to choose an investment portfolio with an ESG mandate over a more traditional portfolio. 
We will begin to offer these portfolios in the second quarter of this year, so it’s still about sixty days away. There are some technical reasons for this that I would be happy to talk about with anybody one on one. If you would like to discuss switching your portfolio to an ESG mandate please give us a call. I do want to thank my clients, and you know who you are, who have been asking about some kind of sustainable investing for several years. Without that prodding I never would have done the research into this fascinating area of the investment world. We also of course want to put in a plug for new clients. There are many people out there who have beliefs that match up with what ESG investing is trying to do, and while the options are growing, the access to these types of portfolios is still limited. It’s unlikely that your company or municipal retirement plans have ESG options within them. Even if you are still working it may be possible to align at least some of your retirement assets with your personal ethics. I look forward to hearing from any of you over the next few months on this topic, or whatever else we may be able to assist you with.