For us, environmental, social and governance (ESG) factors are unconventional sources of risk and opportunity.
The relevance of specific ESG issues varies depending on the industry, so we believe it is vital to integrate ESG analysis into our fundamental valuation analysis rather than apply pre-screening or overlay. We believe that incorporating ESG leads to better decisions. Together with good stewardship, it enhances risk-return characteristics.
Traditional financial indicators are important when assessing companies, but they only show the end result of a firm’s activity. They overlook key inputs that provide the context within which the results are generated: strategy, the business model, corporate culture, and ESG factors.
They may show what is spent on pay, but important measures like staff turnover or spending on training are rarely featured. Similarly, a balance sheet shows the investor a monetary value of the physical assets, alongside certain intangible assets, but it does not explain the strength of the human, environmental or regulatory capital because it is hard to attach a monetary value to these factors. Financial statements do not attempt to do this, yet strong ESG factors have the potential to
create more than just the monetary value of the net assets.
Auditors use the phrase ‘contingent liability’ to describe future obligations too uncertain to be quantified. These are created when a company chooses to compromise the future in order to flatter short-term results. This contingent liability might be deferred for a set period, but it can never be avoided and results in negative financial consequences for shareholders when it is realised.
We see ESG as a ‘contingent asset’ because it can deliver more from a given set of resources.
A sustainable and long-term active manager chooses companies that will be the most resilient over time. ESG and wider ‘extra-financials’ are important components, together with good active stewardship – from both investors and management.
We believe that active stewardship and engagement should bring together company management, shareholders and asset owners to manage the risks and opportunities and improve outcomes. Active stewardship is also crucial to meet clients’ needs and make a positive impact on companies.
Ultimately, we believe that ESG is a tool to create superior risk-return for our portfolios. It helps us to make a positive difference to our clients, to the companies we own, and to society through responsible long-term investment.
Ben Yeoh, senior portfolio manager, RBC Global Asset Management
Column sponsored and supplied by RBC Global Asset Management