This annual report on environmental and social externalities and governance (also referred to as ESG) for the Global Opportunity team1 discusses ESG integration within the investment process, company engagement, the carbon footprint of the portfolios and summarizes participation in collaborative initiatives and relevant MSIM policies.
ESG and the Sustainability of Competitive Advantage
The Global Opportunity team’s investment process integrates analysis of sustainability with respect to disruptive change, financial strength and environmental and social externalities and governance (also referred to as ESG). We view ESG as a component of quality and consider the valuation, sustainability and fundamental risks inherent in every portfolio position. As bottom-up investors, we do not apply top-down ESG positive/ negative screens to a benchmark. Nor do we utilize ESG scorecards from third parties which rank companies versus industry peers. In other words, ESG in isolation is not a principal driver of our investment thesis; it is but one component of our quality assessment.
Our ESG analysis focuses on a company’s ability to sustain competitive advantage over the long term. Areas assessed include environmental management to minimize externalities, reduce consumption of energy, water and other resources and mitigate costs thereby improving profitability; social factors such as consumer product safety, human capital management, supply chain management and regulatory impacts; and governance issues such as management incentives, capital allocation, independent boards and transparent accounting.
Within the emerging markets, where rule of law and corporate governance standards can be lower than developed markets, additional due diligence steps are necessary. Risks stemming from corruption, political instability, governance and accounting issues must be thoroughly investigated. For every emerging market company, we typically commission a full due diligence report, including a background check on company management, board directors and cross-holdings, court and tax filings, and local language press to assess governance risk.
Incorporating ESG-related potential risks and opportunities within an investment process is about ensuring long-term stewardship of capital. Over extended time horizons, we believe that ESG risks are more likely to materialize and externalities not borne by the company are more likely to be priced into the value of securities. Therefore, we continue to innovate and evolve our process and believe that integrating ESG within our investment analysis improves the risk and reward profile of client portfolios.
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