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October 16, 2020
Sustainability: Material Actions Speak Louder Than Words
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October 16, 2020

Sustainability: Material Actions Speak Louder Than Words


Sustainable Investing

Sustainability: Material Actions Speak Louder Than Words

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October 16, 2020

 
 

Sustainability analysis is an integral element of the Applied Equity Advisors portfolio decisions. Over the years, while remaining true to our core investment process, the Applied Equity Advisors team has gradually refined and tweaked that process, striving to add value in our quest to deliver superior returns relative to our benchmark. As a result, we are able to offer portfolios that better reflect our commitment to sustainability and align more directly with the United Nations Sustainable Development Goals.

 
 

The United Nations introduced its Sustainable Development Goals (SDGs) in 2015, designed to be the sustainability blueprint for countries across the globe. Recently, we have witnessed a notable increase in the number of institutional requests for investment product tied to sustainability, and aligned with the SDGs specifically. The SDGs were not originally designed for the corporate or investment world. The question in our minds was, could we build a bridge within our portfolios to the SDGs by focusing our sustainability analysis on material corporate issues with regards to sustainability?

We think so. Absolutely. For example, the World Business Council for Sustainable Development in collaboration with DNV GL (an Oslo-based “global transformation” firm) found that among the 250 global companies surveyed in 2019, 82% have reported on the SDGs. Similarly, the Sustainable Development Investments Asset Owner Platform (SDI AOP), whose current members have a collective $1.0 trillion in AUM, helps investors assess companies on their contribution to the SDGs. That companies can make that connection to the SDGs in terms of their revenue streams implies that we as portfolio managers can create portfolios that are in alignment with the SDGs.

Again, the challenge for Applied Equity Advisors is effectively linking the sustainability alignment of the 20-25 holdings of our Global Concentrated ESG portfolio to the SDGs while meeting portfolio performance objectives. By concentrating on the material sustainability for the portfolio constituent companies, we think the outcome has been positive and reflective of a commitment to sustainability and the SDGs.

 

 

Aligning with the SDGs: Materiality Matters

To determine what constitutes a material issue for the companies being considered for inclusion within AEA investment portfolios, we look to the Sustainability Accounting Standards Board (SASB) and the SASB Materiality Map® for guidance.

Why the SASB? Well, independent third-party research has shown that stocks in which the companies devote more resources in areas deemed material and less in those that are not - as defined by the SASB - should demonstrate better stock price performance over the longer term.1

Taking things a step further, a company’s focus on material sustainability issues may also provide alignment to the SDGs, as posited by Costanza Consolandi and Robert Eccles in the MIT Sloan Management Review.2 There are two parts to their published thesis:

1. Knowing what constitutes a material sustainability issue for a given company.

2. Having the ability to measure a company’s contribution to any of the SDGs.

With regards to the first question, we addressed this same issue in our November 2019 paper “ESG Investing: Living in a Material World,” summarizing the concept of materiality with this simple example:

Serving fair-trade coffee in the corporate cafeteria might reflect ethical behavior, but won’t increase shareholder value. However, a food distributor reworking supply-chain logistics to minimize truck routes will improve the carbon footprint of the planet and reduce fuel costs, a positive material outcome.

As per the second question, the challenge from an investment perspective is how to select and subsequently measure a group of portfolio holdings that will meaningfully align with the SDGs, particularly if the primary investment mandate is to perform against a benchmark. We find it’s a bit like managing to two benchmarks: alignment with the SDGs and relative performance against the MSCI World Index. But the AEA team has found that selecting companies that focus on material issues through the SASB Materiality Map® creates a way for us to more directly align with the SDGs.

When considering the impact a broad-based portfolio representative of the global markets has on the SDGs, we note that some sectors and industries tend to have a greater potential contribution on SDGs than others. Similarly, certain material issues as defined by SASB Sustainability Dimensions will impact a greater number of SDGs (Display 1).

 
 
 
DISPLAY 1: A Sample of SASB Materiality Issues Mapped to the United Nations Sustainable Development Goals
 

Source: Consolandi and Eccles - “Supporting Sustainable Development Goals Is Easier Than You Might Think” (Feb 2018), TruValue Labs and MSIM Applied Equity Advisors – May 2020. The content of this publication has not been approved by the United Nations and does not reflect the views of the United Nations or its officials or Member States. See https://www.un.org/sustainabledevelopment/sustainable-development-goals for more details on the Sustainable Development Goals

 
 

 

As suggested by the chart, 60% of all SASB material issues map directly to SDG 3: Good Health and Well-Being, while only 13% of SASB material issues map to SDG 4: Quality Education. Thus, a broad-based portfolio that includes companies from a diverse set of sectors will not perfectly map to all the SDGs. However, constructing a portfolio that focuses on companies having a material impact on sustainability should have a higher impact on SDGs than one that does not.

The SDG Solutions Assessment: A Practical Portfolio Application

AEA has been managing our Global Concentrated Equity strategy since January 2008 and incepted our Global Concentrated ESG Equity strategy in September 2018.

With our Global Concentrated Equity ESG strategy, we seek to provide a highly-active, style-flexible, global equity portfolio that will outperform its MSCI World benchmark over the longer term, and which will be comprised primarily of companies that address the sustainability/ESG issues most material to their businesses and relevant to their stakeholders. As discussed above, the resulting portfolio is designed to align with the SDGs.

Morgan Stanley Investment Management continually reviews datasets specifically designed to measure the potential contribution to the SDGs in publicly traded portfolios. The data identifies companies in which products and services - and revenue streams - can make a positive (or negative) contribution towards attaining the SDGs (Display 2). We recognize that revenue streams are backward-looking, but believe they are directional as to a company’s future impact on the SDGs, and will therefore align our portfolio decisions with our clients’ interest in sustainability. A clear “win/win” in our minds.

 
 
 
DISPLAY 2: The AEA Global Concentrated Equity ESG Portfolio Alignment with the UN SDGs
 

Source: ISS SDG Solutions Assessment data as of June 30, 2020.

 
 

 

In the case of a large software firm holding, their commitment to cloud computing helps to reduce energy consumption, waste, and carbon emissions (SDG 13: Climate Action), while it simultaneously can help improve profitability by lowering the need for capital investment in physical IT infrastructure. What can be good for the globe can in fact be good for the bottom line.

A Final Thought

It is our firm belief that a continued focus on material issues as defined by SASB has the potential to have a pronounced positive impact on sustainability considerations, specifically on the SDGs, and our investment results. This is especially true as data improves with more companies embracing the SDGs. As investors, AEA, in collaboration with the Morgan Stanley Global Stewardship group, has the opportunity to influence companies’ decisions through engagement with their management teams.

We’ve said it before, but it is worth repeating: AEA believes our integrated approach will continue to drive good corporate citizenship, while helping investors thrive in the world of sustainability investing.

In short, our portfolio “actions” should speak for themselves.

 
 

1 Corporate Sustainability: First Evidence on Materiality. Mozaffar Khan, George Serafeim, and Aaron Yoon, March 2015. Past performance is no guarantee of future results.
Consolandi and Eccles - “Supporting Sustainable Development Goals Is Easier Than You Might Think” – February 2018.

 
 

 

RISK CONSIDERATIONS
There is no assurance that a portfolio will achieve its investment objective. Portfolios are subject to market risk, which is the possibility that the market values of securities owned by the portfolio will decline and that the value of portfolio shares may therefore be less than what you paid for them. Market values can change daily due to economic and other events (e.g. natural disasters, health crises, terrorism, conflicts and social unrest) that affect markets, countries, companies or governments. It is difficult to predict the timing, duration, and potential adverse effects (e.g. portfolio liquidity) of events. Accordingly, you can lose money investing in this portfolio. Please be aware that this portfolio may be subject to certain additional risks. ESG strategies that incorporate impact investing and/or Environmental, Social and Governance (ESG) factors could result in relative investment performance deviating from other strategies or broad market benchmarks, depending on whether such sectors or investments are in or out of favor in the market. As a result, there is no assurance ESG strategies could result in more favorable investment performance. In general, equities securities’ values also fluctuate in response to activities specific to a company. Stocks of small-and medium-capitalization companies entail special risks, such as limited product lines, markets and financial resources, and greater market volatility than securities of larger, more established companies. Investments in foreign markets entail special risks such as currency, political, economic, market and liquidity risks. Illiquid securities may be more difficult to sell and value than publicly traded securities (liquidity risk). Non-diversified portfolios often invest in a more limited number of issuers. As such, changes in the financial condition or market value of a single issuer may cause greater volatility. Derivative instruments may disproportionately increase losses and have a significant impact on performance. They also may be subject to counterparty, liquidity, valuation, correlation and market risks.

 

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