The days when investing with an eye toward environmental, social and governance practices was simply a matter of excluding certain stocks are long gone. Today it's all about engagement — working with corporate management to enhance how they handle issues such as income, gender and racial inequality, sustainability and natural resource management.
The reason things have changed so much is the realization that working with companies on ESG issues can lead to better long-term outcomes for the companies, their employees, suppliers, shareholders and other stakeholders, not to mention the world.
“Many management teams have come to appreciate the importance of dealing with material ESG risks,” said John Streur, president and CEO of Calvert Research and Management. “What's facilitating it is the fact that it's becoming clear that certain environmental issues and certain social issues represent business risk and opportunity, and need to be dealt with.”
Speaking on the sidelines of a recent Pensions & Investments conference, Streur explained how he and his team have been working with corporate management groups across industry sectors toward long-term change, which, in the process, may have a positive impact on the performance of Calvert's portfolios.
“We conduct ESG research on a broad universe of companies throughout the world, and what drives an engagement is our ability to identify opportunities for companies to strengthen their practices,” he said, adding that engagement can mean a simple phone call. “We have a process for working through that and finding, within specific industries, engagement opportunities. For example, if we own a position in a company, we want to work with that management team to strengthen the company's competitive position.”
Streur said that more than half the time Calvert has engaged a company on ESG issues, management has agreed to take action. When it doesn't, Streur and his team will consider a shareholder resolution, using the power of the proxy.
“Proxy voting is part of our engagement effort,” he said. “Our work on annual resolutions is thoughtful and detailed. We have a very strong record of supporting ESG proposals, whether it's for improved diversity, improved climate risk disclosure or improved overall disclosure and transparency.”
He said the issues are framed in a financial context. So while the specific issues may be different — those presented to a health care company would be different from those presented to a chemical company — the end goal is the same: Improving the financial performance and long-term viability of a company. “The focus on financial materiality is really important to getting things done,” Streur said.
One issue Streur said is getting more traction is inequality — income, racial and gender.
“Broadly speaking, equality or inequality is a business issue for companies that have exposure to the need for diversity, which we would say is all companies,” he said. “We find that companies that can provide an attractive workplace for a diverse employee base across race and gender have the ability to produce better financial results than companies that can't provide that.”
Income inequality relates to companies having major exposure to lower-wage employees, whether directly or indirectly, through a supply chain. Resolving the issue of income inequality has benefits far beyond the bottom line, according to Streur.
“Whether a big U.S. retailer, a fast-food giant or a sophisticated technology company that has a global supply chain, these companies need to create employee well-being in order to have a long-term, productive employee base,” he explained. “And whether direct or through the supply chain, it's a very relevant business issue in terms of accessing a labor pool, creating well-being for that labor pool and, ultimately, creating economic performance in a region or country. That's a bigger-picture issue, but we know that companies are sensitive to this.”
The problem has been that for a long time, many companies paid lip service to inequality and simply looked to hit targets that would suggest a level of equality. But over the years, C-suite executives have made the connection between diversity, productivity and profitability.
“Companies need to develop the skills and expertise to provide an attractive workplace for diverse employees. It involves learning skill sets and development,” Streur said. “You can't just try to hit the numbers.
“There's academic research that points to the fact that companies that can master this, and do it really, really well, achieve higher productivity and better financial results,” he said. “There are a few leaders in this area, and there is a lot of opportunity for companies to strengthen their abilities, their practices and improve their results.”
The situation is similar with ESG integration broadly, including some institutional investors who are leading the way and others still learning. Efforts by the Sustainability Accounting Standards Board (SASB) and the United Nations-supported Principles for Responsible Investment (UNPRI) to create methodologies for measuring ESG, and to increase transparency and visibility, have played a big role in educating both asset owners and corporate management.
“There is a set of asset owners who are at the point of integrating ESG quite comprehensively, and their questions are more advanced than the rest of the pack,” Streur said. “The advanced questions are around concepts of measuring ESG risk in portfolios, in funds, and evaluating the options for dealing with those risks. The others are about how to understand the list of risks and what the options are.”
What has changed over the last few years, Streur said, is the fact that institutional investors are no longer debating whether or not they need to understand ESG in the first place.
“In the past there were asset owners who said, 'This doesn't matter, this isn't real, it isn't relevant,'” Streur said. “Those days are behind us. All the large asset owners we deal with have said, 'We're going to work to understand ESG. We're going to figure out how this fund is going to incorporate our ESG into its investment process.' So everybody is on the journey, but there are only a few players who have begun to master it. It's still early days, and it's going to play out for the next several years.”•