ESG Scores

Dec 2018

Comparing apples to oranges

Specialist research on environmental, social and governance (ESG) factors can be useful. But we find that data providers, such as MSCI and Sustainalytics, are sector relative and subjective on the materiality of ESG-related risks or opportunities. This information may serve as inputs into our analysis, but they do not drive our stock selection.

When we identify potential risks that threaten the sustainability of returns, we contact senior management directly. We engage with managements and the boards of companies across our portfolios, including those in Global Sustain – our newest ESG-integrated offering. On a case-by-case basis, we discuss material ESG factors that could impact sustainable high returns on capital. These could include issues that may help ensure companies remain relevant with customers, improve employee engagement and stay on the right side of governments and regulators. These factors could include, where relevant, environmental issues, such as carbon emissions, raw material sourcing and packaging. They may also include social issues, such as supply chain labour standards or product quality.

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We review ESG information from data providers, but only as a supplement to our own research

Richest ESG research comes from direct engagement

Many years of investing have shown us the world is grey, not black or white – meaning that, over time, companies can have environmental, social or governance issues in a variety of types and magnitudes. Their severity and plans for resolution are key. We look to see sensible solutions and monitor progress on issues over time.

To succeed in this effort requires more than data-driven ESG scoring. We review ESG information from data providers, but only as a supplement to our own research – the most useful of which is a compiled history of a company’s controversies. Understanding management quality requires direct engagement with company management. In our view, this is so important that we have engaged directly with companies on all kinds of material issues, assisted where relevant by our firm’s corporate governance team.

Sector-relative scoring has shortfalls

One of the challenges of ESG risks is that, by their nature, they can be unexpected with potentially enormous consequences. Examples include oil spills or product recalls. Certain industries have inherent risks but, even with these known risks, it can be extremely difficult to assess the investment implications of unexpected, low-frequency, high-impact events before they occur. Quantitative scoring systems do not offer sufficient perspective for assessing the likelihood of such events. Through engagement, we seek to mitigate these risks by understanding the priorities of a company’s management.

While the scores in individual areas from MSCI and Sustainalytics may point out areas to study, we are wary of scoring that evaluates companies relative to their sector and industry peers rather than on an absolute basis, inclusive of all industries. The problem with evaluating companies versus its sector peers is that, if a software company scores unfavourably versus other software companies, it may end up with a worse environmental score than a mining company that scores favourable versus other miners on environmental issues. This makes little sense to us. In addition, we find many of the scores fairly unconvincing, as they can depend more on the corporate’s engagement with the process of measurement than with the underlying issue. We do not select companies based on their scores.

The ultimate score is whether the company is a sustainable compounder

More fundamentally, the ultimate measure of sustainability is the long-term success of the company. We believe that good environmental and social behaviour brings financial rewards over our long-term investment horizon. For all of these reasons, we do not outsource ESG analysis to a team of ESG researchers, within or outside the firm. The responsibility for ESG analysis sits directly with each portfolio manager. This applies Global Sustain, the newest addition to our lineup, as well as all of our strategies.

Bruno Paulson

Managing Director

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