Environmental, Social, & Governance
ESG Integration just makes sense. Relying purely on fundamentals and financial metrics to drive an investment thesis leaves out a significant portion of a company's overall profile. Especially with companies shifting toward improving their sustainability profiles, Environmental, Social, and Governance factors play a strategically important role in the company's capital allocation and innovation process. Without looking at the full profile of a company from both a fundamental and ESG perspective, investors cannot argue that they are generating alpha by seeing something that the market is missing. ESG is inherently risk mitigating, as it allows investors to see material controversies on the horizon that simply looking at a company's financial statements and SEC filings would not reveal.
Carbon emissions, energy conservation, raw material sourcing, waste reduction, and water usage are just a few examples of important factors to consider when looking at the environmental profile of a company. Companies from almost every industry, from consumer products or food & beverage to pharmaceutical companies, have been investing significant amounts toward improving their sustainability profiles.
Material social factors usually consist of factors like product quality and safety, human capital management, and supply chain responsibility & management. Again, these factors vary based on the industry a company is operating in. A tech company like Apple, for example, would have Data & Security as a significant social factor, as they have a responsibility to their customers to protect their data. If investors are aware that a software company has bad security and data protection practices, then they should not be surprised by a data breach that could compromise millions of users' information and damage their reputation. A controversy like this could not be detected by simply looking at a company's financial statements.
Business ethics, governance structure, women on board, and insider ownership/compensation structure in a company's management serve as material governance factors in ESG analysis. These factors play an important role in encouraging companies to promote equality and a fair governance structure and to align management's incentives with those of the company.