One of the types of investments that have grown to prominence over the last few years is ESG Investments. ESG stands for Environmental, Social, and Governance guidelines when considering an investment. This is no surprise given society's collective sensitivities to environmental and social issues nowadays. People don't want to invest in companies that are destroying the environment. People also don't want to invest in companies who sexually harass their employees, or discriminate against minorities or underprivileged groups, or do any other bad things for that matter.
This makes sense, not only because it is morally reprehensible for companies to do those things, but also because it is quite dumb for a long term investor to invest in companies that do those things. Long term investors want a company to be successful for a long period of time, so that they can continue to benefit from the prosperity of the business. Businesses who damage the environment and who don't provide value will not be sustainable long term. Businesses who treat their employees or customers poorly will not be successful long term.
An Example with Wells Fargo
I know we could all point to anecdotes of companies behaving poorly and those companies are still around (ahem, banks in 2008 anyone?). But they usually don't make good investments (Citibank trades today for roughly about 1/10th of its all time high in 2006). As an example, if you were a shareholder in Wells Fargo over the past 5 years you've seen your share price cut in half basically due to the scandals caused by improper incentive schemes and fabricated accounts. Wells Fargo is an otherwise excellent bank which was previously seen as very well managed. But if you treat your customers poorly, and then compound that failure by trying to cover it up, the market will punish you, and your shareholders.
So I think most investors, and especially most long term investors would be interested in seeing some kind of information on a company's environmental, social, and governance policies before they decide to make or continue an investment in the company. And happily for investors, many companies are providing just that, in their annual and quarterly reports.
Applauding the Efforts Made by Companies
We're investors in some Canadian energy companies and they especially like to highlight their environmental track record and their efforts to mitigate the destructive aspects of their business which are unavoidable. Of course this information always comes directly from the company so there is also an element of salesmanship to the information provided. Nevertheless, the information is welcome and the efforts by the companies should be applauded.
Could there be laws passed which required certain disclosures of ESG policies for companies? Of course there could be. There are required disclosures for all kinds of things and there's no reason why environmental or social information couldn't be included in a list of required disclosures. The problem with this is that many investors are not going to read those company disclosures anyways. Prospectuses and Annual Reports can be hundreds of pages long already. Most people couldn't read all of those reports even if they wanted to. So along comes the investment industry to save the day and offer these investors packaged products which are stamped and certified 'ESG'.
For those investors who don't want to do the research on their own, the fund company will do the research for you. Sounds like a good solution right? Of course there are no governing bodies which certify these funds and people often disagree over what should qualify. Is an energy company automatically disqualified because its business pollutes, even if they are in every other way an upstanding corporate citizen? If that's the case, where do we draw the line? Don't all businesses cause pollution in some way? And for social guidelines, who writes the rules on what is appropriate? Does one bad employee disqualify an entire company?
These are all valid and hard to answer questions. That's why ESG investments are so hard to understand, and have been somewhat disappointing for many investors who thought they were getting one thing, and ended up with an investment which is very different. I'm not even sure regulation is even the optimum solution in trying to achieve better environmental and social outcomes.
In some cases environmental regulation is clearly required, but in other cases, the market is actually doing an ok job of cleaning up environmental problems. Electric cars still require subsidies to be competitive, but the day is quickly coming where consumers will demand electric cars not only because they are nice to drive but because no one will want to be seen in a dirty polluting internal combustion engine car, regulation or not. Coal energy plants are disappearing in North America and it is market forces which is causing this, not regulation. I think regulation can assist these trends in a positive way but regulation that is too heavy handed comes with its own problems.
So in the absence of regulation what should we do to try and account for environmental and social factors in our investments? Well ironically, I think we are already incorporating ESG concerns into our investment philosophy. As I've said, in order to be good long term investment, a company needs to be able to provide a lot of value to its customers, and ultimately to society. They will also need to act ethically and treat all of their stakeholders well, especially their employees and their customers.
This doesn't mean they will be perfect. I think everybody recognizes that fossil fuels are not good for the environment and we should try to move away from using them. But that doesn't mean energy companies don't provide any value. It's a more complicated question than that, and requires a more nuanced response than simply labeling something unethical just because it doesn't fit into an arbitrary classification.
Sustainability and Competency
In every company we invest in, we look for good sustainable businesses and competent ethical management. If we do a good job of identifying these characteristics, our ESG concerns should take care of themselves.
- Craig White, BA, LL.B., CIM
Craig White is an Investment Advisor at Endeavour Wealth Management with Industrial Alliance Securities Inc, an award-winning office as recognized by the Carson Group. Together with his partners he provides comprehensive wealth management planning for business owners, professionals and individual families.
This information has been prepared by Craig White an Investment Advisor for Industrial Alliance Securities Inc. (iA Securities) and does not necessarily reflect the opinion of iA Securities. The information contained in this newsletter comes from sources we believe reliable, but we cannot guarantee its accuracy or reliability. The opinions expressed are based on an analysis and interpretation dating from the date of publication and are subject to change without notice. Furthermore, they do not constitute an offer or solicitation to buy or sell any of the securities mentioned. The information contained herein may not apply to all types of investors. The Investment Advisor can open accounts only in the provinces in which they are registered.
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