The ABCs of ESG: What It Is, and What It Is Not

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The ABCs of ESG: What It Is, and What It Is Not
By Hallie Kraus, CFP®, CRPC®

So, let’s say you’ve chosen one of the most accessible methods to make an impact: ESG investing. You happily buy some shares of an ESG mutual fund and think to yourself… what does holding this fund really do, anyway?

At face value, you’re buying a fund that has a specific framework for the companies it invests in, based on their environmental, social and governance practices. (We’ll discuss this in our next blog post and highlight some examples.) But there is a lesser known, equally important component to ESG investing. Investing in these funds also means that you’re supporting a significant level of dialogue between the mutual fund company and the companies it holds a stake in. Sometimes, that dialogue turns into much more overt pressure to incorporate more equitable and sustainable business practices.

Every asset manager is different, but it usually involves a combination of the following:

Shareholder Activism

Unlike traditional activism, shareholder activism doesn’t involve marches and boycotts, but like traditional activism, it does involve voting. You see, shareholders aren’t just entitled to quarterly dividends — depending on the class of shares, they’re also entitled to distinct voting privileges. And when an ESG mutual fund company owns a significant percentage of shares of a company, it leverages its rights as a shareholder to bring about sustainable and societal change. In addition to voting on a wide range of business decisions (such as board of director elections, environmental goals, executive compensation, among other issues), they may also propose their own recommendations to the board (called shareholder resolutions) that are voted on during the corporation’s annual meeting.

Engagement

If shareholder activism is analogous to voting in the political system, shareholder engagement most closely resembles advocacy. In this case, the “advocates” are the members of the mutual fund’s policy and research team(s), who meet directly with company executives and encourage them to adopt higher sustainability and governance standards. The asset managers will also share their expertise, research findings and other resources to support their demands. Depending on the willingness and progress that the company shows during the engagement process, the portfolio managers may change the fund allocation to invest more — or less — in that company.

What does this look like? Let’s look to Parnassus Investments as an example. Parnassus is a San Francisco–based firm and one of the first entrants in the world of impact investing, decades ago. Beginning in 2013, they voted in support of a shareholder resolution that called on Mondelez, which owns snack brands like Oreo, Ritz and Cadbury, to improve its packaging waste. Over the next five years, Parnassus also directly engaged with its head of sustainability and corporate security, and by 2018, the resolution grew to receive 31% of the shareholder vote. In October of that year, Mondelez announced that all the company’s paper packaging will be sustainably sourced by 2020, and all of its packaging will be recyclable by 2025. We love to see this kind of shareholder activism and engagement in action!

Advancing and Developing Public Policy

In addition to voting and appealing directly to executives to bring change within corporations, some ESG mutual fund companies broaden their advocacy efforts to influence policy. Portfolio research teams at Impax Asset Management, for example, serve as facilitators to help policymakers and investors understand how subsectors within industries operate. This makes it possible to identify the trends and components within industries that are needed to support sustainability.

Many mutual fund companies will also band together to expand their clout worldwide. In 2019 alone, Impax wrote or signed letters to at least 11 public entities, including the EPA, three state legislatures, the SEC, and the government of Bangladesh, on issues ranging from upholding air quality standards, to increasing funding for energy efficiency, to maintaining corporate disclosure requirements — just to name a few! Both Impax and PIMCO are also part of the Institutional Investors Group on Climate Change, a network of 240 asset managers and pension funds that works with policymakers to advance climate policy on the global stage.

The Power of ESG Investing

As wealth managers, we’re excited that ESG mutual funds have become uniquely positioned to serve as a link between investors, businesses, and government, and appreciate how they’re doing the legwork and research to identify a sustainable path forward. By investing even a small amount in ESG funds, you are promoting a dynamic discourse and advocacy between institutions that you couldn’t otherwise do on an individual level. But that’s just part of it! In our next piece, we’ll explore the more granular side of ESG investing: how fund managers actually put your dollars to work.

If you’d like to learn more about ESG investing, check out Part III of our blog series on the topic here.