Environmental, Social, and Governance (ESG) Guidelines for Portfolio Management

As portfolio managers, we are under increasing pressure from clients to comply with current (and ever-changing) Environment, Social, and Governance (ESG) standards when choosing corporations to invest in. But what are these standards? Who sets them? Where do the standards come from? What data underpins them?

Those of us with long experience in the industry have learned that who provides us with portfolio recommendations is as important as what they recommend. Such attention is especially warranted when a new trend, such as ESG begins to exert significant influence and becomes widespread. Yet, we must know how to conform our investing style to this new set of metrics.

Bloomberg predicts “ESG assets may hit $53 trillion by 2025, a third of global AUM.” [1]   Investors are driving this growth and are pushing portfolio managers to move funds from corporations with low scores on ESG standards to those with higher scores. While there are many subcategories under the broad umbrella of ESG, investors are focused intensely on global warming. They want and are demanding that we disinvest in corporations with high rates of GHG (Greenhouse Gas Emissions), which includes carbon discharge.

If you doubt the strong sentiment among investors over global climate change, the recent proxy fight which occurred at Exxon in which two environmentalists were voted onto the board of the corporation in place of the nominees by the management should convince you of the validity of their sentiment.  

One of the reasons for the keen focus on GHG emissions is we already see the effects of global warming.

“In 2019, global mean sea level was 3.4 inches above the 1993 average, the highest annual average in the satellite record (1993-present).”  Because the globe is getting warmer, as a result, the oceans are getting warmer as well. These factors combined are responsible for the extreme weather events in the U.S. in recent years, from destructive hurricanes, drought, and wildfires in the west.  

 The number of extreme weather events affecting our coastal areas will increase in frequency and strength and cause greater destruction of capital investments along our coasts with concomitant damage to our economy. Between 2018 ($91 B) and 2019 ($45 B), destructive weather events, including fires in the west, caused combined economic losses of $136 Billion. Damage costs due to weather totaled $95 B in 2020. Unfortunately, 127 MM Americans are hostages to fortune because they live in coastal areas, that is, 40% of Americans live on 10% of the country’s land area. These figures point to a growing financial liability that will face the U.S. coastal areas as time goes on. Mitigation efforts are expensive, with New York City facing expenses of more than $2 B for its project to protect the financial district and other parts of downtown Manhattan.

To assess climate impact on corporations, many organizations have cropped up in the last few years to gather and issue data on climate change and other ESG standards. The Harvard Law School Forum on Corporate Governance has produced a summary of the different organizations which set standards. You can find the summary here:  law.harvard.edu/2020/09/21/ [2]

The go-to organization for corporate standards is the Global Reporting Initiative (GRI) which issues sustainability reporting standards and other ESG standards.[3]   According to GRI, they are advised by a fifty-person forum of individuals chosen from “core constituencies in GRI’s network: Business, Civil Society Organization, Investment Institution, Labor and Mediating Institutions.” Hence, this is a broadly based global organization. You can download their standards here: [4]   globalreporting.org/standards/download-the-standards/.

Resources:

[1] https://www.bloomberg.com/professional/blog/esg-assets-may-hit-53-trillion-by-2025-a-third-of-global-aum/

[2] https://corpgov.law.harvard.edu/2020/09/21/esg-disclosures-frameworks-and-standards-developed-by-intergovernmental-and-non-governmental-organizations/#2

[3] https://www.globalreporting.org/

[4] globalreporting.org/standards/download-the-standards/

Contributing Writer: Subject Matter Expert Charles McCain

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