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Over the past month, we have done a couple of posts about ESG investing, notably from my younger colleagues. I have gotten—not pushback, really—but comments to that effect both on the blog and elsewhere. The feeling seems to be, at least to some extent, that ESG is different from what prior generations, which is to say old people (which is to say me), have looked at and that somehow this represents a change.
As a cranky older person steeped in the financial world, I get this argument. I share it emotionally to some degree and totally see where it is coming from. Can’t we just make money here? Isn’t that what firms and stocks are for? I get it.
The Forest and the Trees
But I also believe this argument is wrong. Not because it shouldn’t matter, but because ESG is a wider and more effective look at the factors we are already assessing. To use an appropriate metaphor, historically we have looked at companies (i.e., trees) without looking at the wider economy (i.e., the forest). And that made sense, because historically the trees could thrive independently of the forest. The health of the forest was assumed to be fine, regardless. And if that is the case, why worry about it? What we have learned over the past 20 years, though, is that if the forest is threatened, so are the trees. Here, I want to abandon this metaphor for a moment and go back to finance.
Remember the great financial crisis (GFC)? When the system itself looked threatened? When even strong companies, or what were thought to be strong companies, teetered and collapsed? In that case, it was proven that the larger system (the forest) mattered. That trees couldn’t thrive in the middle of a forest fire. That looking beyond the companies, at the systems and the systemic risks, was necessary as investors. So far, so good, and this view is now accepted. I field questions on Evergrande and systemic risk on a regular basis.
But why should we limit this broader perspective to the financial system itself? Why shouldn’t we extend it to areas like the environment, the social impact of firms, or their governance? What makes them not relevant in the same way we learned the broader financial system was relevant?
A Natural Extension
Looking at it that way, ESG becomes a natural extension of the broader perspective we got from the GFC. It looks like a way to take into account risks that will affect our investments, before we get a systemic crisis. It looks like what we should have been doing with the financial system itself, before the GFC.
And that holds independently of politics. Shouldn’t we be looking at all risks and opportunities? Shouldn’t we be considering the longer term? Both of those are investing 101. ESG gives a new window into that process, and it’s one that can make financial sense.
This perspective is getting more widespread. Almost all investment companies now offer at least a nod to ESG processes, if not specific products. ESG, like any useful discipline that can help investors understand and improve their analysis, is rapidly becoming a standard. You don’t have to agree with some of the politics of the ESG advocates to see the real utility of the mindset or to take advantage of it.
And that is where we have been for years at Commonwealth. We started looking at this as our advisors got interested. But over time, we have realized the real value it can add—in all areas. For the past 10 years and more, we have been looking at this and working with the sponsors, and it just keeps getting more and more relevant.
It’s Not About Politics
As an investor, I don’t care about the politics. Note that I have not mentioned politics, or climate change, or sustainability, or any other politically charged terms. All we are looking at here are systemic risks and opportunities offered by the environmental, social, legal, and financial contexts within which any company operates. All we are doing is extending the context in which we evaluate those companies. All we are doing is better understanding our investments. That is something I want to use in my portfolio.
Investments are subject to risk, including the loss of principal. Environmental, social, and governance (ESG) criteria are a set of non-financial principles and standards used to evaluate potential investments. The incorporation of ESG principles provides a qualitative assessment that can factor heavily into the security selection process. The investment’s socially responsible focus may limit the investment options available to the investor. Past performance is no guarantee of future results.
