Utilizing the skills and experience of its core professionals, Clearbrook has partnered with investors to adapt their portfolio’s strategy and underlying investments to better reflect their cultural beliefs and return objectives. Over the years, Clearbrook has seen the ESG space go through many permutations of nomenclature, but in the end, it is an investment strategy that an institution and its constituents can be proud of philosophically as well as embrace to meet their financial needs. To some, it’s simply an elimination strategy, removing “sin stocks” such as Alcohol, Tobacco, Gaming and Weapons. To others, it may mean incorporating those companies into a portfolio in order to initiate a proxy vote and change certain negative biases within a company’s culture through labor practices, board composition or education programs for employees. It could also be an impact investment that adds alpha, as more managers focus traditional tools with more mission related strategies. These would include agriculture, healthcare, technology and alternative energy.
The first step in establishing an ESG mandate is defining the ultimate goal and develop a new mission statement that speaks to the spirit of the plan. This should be a positive affirmation of beliefs which establish the ground rules and parameters. One of the most popular misconceptions is “FOMO,” the fear of missing out on certain investments. For example, “What if oil prices rise? How will the investments perform?” The enhancements of risk mitigation, portfolio attribution and investment acumen on the part of your consultant will help determine what the portfolio is or is not exposed to and the overall impact. As is commonly known, performance issues arise when a portfolio does not perform to expectation, as no portfolio is immune to all market cycles. If you begin with a portfolio that is designed to perform in a certain manner, modifications are made as the macro outlook and relative value opportunities change. Investors need to be kept apprised of ever-changing market cycle, market condition, cyclical correlation, structure, drivers of performance and realization of gains and losses appropriate in their portfolio.
Once a mission statement is determined, the work begins as to how that can in fact be accomplished within the arena of commonly used assets. Much like playing three-dimensional chess, in addition to stock vs bond, growth vs value, small cap vs large cap, an investor now must consider activist versus elimination, faith- based, environmental and governance goals, and alignment with their family’s or organization’s mission. We define ESG as taking a long-term view that aligns with a clients social and societal beliefs to using sustainable methods to achieve their investment goals. Clearbrook knows that each of our clients have a diverse view as to how their assets should be managed and for those that are interested in incorporating ESG goals. There are a number of different metrics that can be used, but we favor starting with the United Nations 2030 Goals, which offer a good basis for formulating a client’s investment strategy. As the client progresses through the process of what is important to them, we begin to incorporate these goals into their investment process and then into practice, making the mandate very clear and concise for all involved.
As passive and index oriented investing has increased in recent years, ESG investing is one area where active management will firmly have a place because the strategy is so customized. With this in mind, numerous investment products have been introduced recently. According to Morningstar, over the last 10 years, over 2,500 mutual funds, ETFs and separate account strategies have been created with almost 20% of those portfolios having been created in the last 12 months. Each having a different idea of ESG. Some trends of investing are just mirroring the changing composition of the markets.
Performance
The common misconception about ESG benchmarks is that you are giving up return. This is not necessarily the case. One of the earliest benchmarks in the space is the MSCI KLD Social Index. Since the benchmark’s inception, May 31st 1994 it has returned 9.77% while the MSCI USA IMI Index has advanced 9.63% annually. Risk has also been comparable. Over the last 10 years for example, their respective Sharpe Ratio’s were comparable with the KLD having a Sharpe of 1.04 and the USA index at 1.03. There are also many exceptional investments where their alpha creation is extremely valuable and contributory. Much of the debate on performance is focused around the appropriate benchmark, beta differential, style drift and time horizon.
A Clearbrook Case Study
In 2015, the trustees of a large university endowment had considered their impact on climate change and how to incorporate their views into their portfolio. Divesting from fossil fuels had been considered and discussed for several years. Students had also approached the trustees to consider divesting to which the investment committee decided to explore the possibility and asked Clearbrook to assist in understanding what the impact currently was in their portfolio. While the impact was not significant it did mean that some positions and strategies would be affected.
It created discussion around what was important about divesting and what types of fossil fuels were considered to be the highest priority and why. As noted earlier, each client can have different goals to address what ESG impact they want to have. Within this specific instance, there was and is a firm belief that in addition to the social concerns about the holding of fossil-fuel-related companies, there is investment merit to eliminating those holdings. Fossil fuels could at some point be considered stranded assets as the global economy converts to an electrified economy powered by renewables.
As the committee progressed, language was incorporated into its investment policy statement to address the views around climate change and its divestment strategy. The process took approximately one year to accomplish this initial stage and the committee set a divestiture goal of five years preventing the need for investment managers to immediately sell any positions. In addition, with Clearbrook’s help, the investment ideas that are aligned with the client’s view were incorporated through a proactive approach.
Society loves acronyms, emojis and instant transmission of thoughts, but ESG investing in its many forms is one of the most dominant drivers in modern investing.