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Investing With Impact

Author: Katy Zhao
Investing with Impact

Building a sustainable future—one that meets the needs of people today without compromising future generations—is an immense undertaking, and a crucial one. Consider that the world population is projected to exceed 9.5 billion by 2050. That’s a 36% increase from today, which will inevitably lead to strains on water, food and other resources. We believe integrating environmental, social and governance (ESG) factors into one’s investment process can help mitigate sustainability issues. What we call “sustainable investing” is not a departure from traditional investment principles. It simply integrates ESG into the investment process. Hence, ESG is one measure of sustainability, and at no point do the objectives sacrifice returns for ESG input or vice versa. Sustainable investing is also one of the fastest-growing asset investment categories, with $6.6 trillion in assets in 2014, up from just $3.5 trillion in 2012, according to the US SIF Foundation (see chart). By employing ESG factors in the process, sustainable investment practitioners attempt to limit risk by minimizing harm to people and planet, and to invest in companies working toward productive and sustainable outcomes.

Using ESG Factors

In practice, Morgan Stanley Wealth Management’s Equity Model Portfolio Solutions team already employs stringent governance diligence on all of our holdings given our belief that strong management is the backbone of any successful company. In addition to evaluating managements’ experience and execution records, we also consider executive compensation, independence of the board, leadership diversity and the selection of independent external auditors ratified by shareholders. Environmental criteria can be more sector specific, but broadly we focus on determining if a company is tracking its environmental footprint and how it measures cost savings or impact as a result of these practices. Having policies in place for water quality, waste reduction and biodiversity is the first step in demonstrating sustainability integrity, in our view. We then evaluate how companies are realizing those objectives and performing against their peers. Social criteria generally relate to labor practices. This is highlighted by a 2011 study by Alex Edmans, a professor of finance at the London Business School, which shows that higher employee satisfaction can lead to better stock returns. To us, this makes perfect sense: Happier employees drive elevated morale, collaboration and productivity. For companies that outsource labor, we examine supply-chain-level practices, which include fair remuneration, business ethics, human rights, equal opportunity and child-labor policies. In our view, every large multinational company should adhere to human rights, equal opportunity and child-labor policies at a minimum. These should be standards, not exceptions to ESG transparency.

Innovative Solutions

Our Sustainable Impact Model Portfolio, for instance, not only seeks individual companies that demonstrate strong ESG criteria, which we call "good actors," but also "solution providers"—companies that actively participate in and/or generate revenue from producing a product or solution that benefits or contributes to one of the portfolios’ seven sustainability themes. These themes were leveraged from MS & Co.’s Sustainable + Responsible Research investing framework and include climate change, water scarcity, food availability, waste management, health & wellness, improving lives and aging population. We recommend investors put capital behind companies that demonstrate a consciousness toward creating a better future.

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