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Activist ESG Investing — The Goldilocks of Responsible Investing

The ESG was an incredible movement. It had momentum and acceleration that was seemingly unstoppable, and for good reason. Everyone wants to save the climate and support treating employees, customers and communities with respect. Everyone is for good corporate governance.

Yet for several years many people, especially behind closed doors and in private conversations, have been skeptical of investing based on environmental, social and corporate governance factors. This skepticism towards ESG investing has reached fever pitch lately.

Why is it? This is because there is a huge disconnect between ESG as a philosophy and as an investment product. ESG is a conceptual idea of ​​new factors that market participants should take into account when investing in and managing companies. Many ESG investment funds took this idea and leveraged it as a marketing tool to raise assets in strategies that relied on quantitative data and easily manipulated ratings, and were far too passive to create a real change. Additionally, there is a widespread perception, if not reality, that investing in ESG means sacrificing returns.

Today, a bear market has exposed these weaknesses and, for the first time, the ESG investing movement is running out of steam. Worse still, these exposed shortcomings in ESG investment funds have opened the door to funds that present themselves as the antithesis of ESG, advocating for the elimination of all social motivation from companies and completely ignoring ethnicity and gender in hiring practices. This drastic reaction to ESG funds does on the right exactly what it criticizes on the left: it takes an extreme position that exploits far-right opinions to weaponize opponents of ESG funds, just as many ESG funds have been created to exploit and militarize ESG acolytes. Ideologically maximizing profits while ignoring social repercussions will lead companies like Purdue Pharma or corporate boards to rationalize potential oil spills through a cost-benefit analysis of potential fines and cleanup costs versus the costs of the prevention. What about worker safety? Should this be sacrificed if the cost of keeping employees safe outweighs the liability and replacement costs of injured employees? Anti-ESG funds focused solely on shareholder value would likely waive the costs and pay the liabilities. Also, does anyone other than these anti-ESG funds really believe that a board or management team isn’t better when it has qualified members with a diversity of perspectives? and life experiences than when he is all white and male?

Of course, environmental, social and governance factors must be considered by management teams and investors, but they are factors that must be weighed and not imposed. These decisions are more complex than both sides recognize. They cannot be made quantitatively, with generalizations or by extremists. They must be made qualitatively, by an active player weighing the pros and cons and pragmatically defending a position that benefits all stakeholders, including shareholders. This is what active ESG investing, or AESG, does.

AESG investing occurs when an activist investor takes a position in a company and actively (usually at board level) and qualitatively analyzes and improves not only the financial, operational and strategic facets of the company, but also its ESG footprint. Funds like Inclusive Capital and Impactive Capital are the leaders in this area, and they look at every investment not just from a shareholder value perspective, but also from an ESG perspective. In many cases, these funds advocate ESG practices in their portfolio companies that advance shareholder value. Other activists, although they focus more on operational, financial and strategic issues in their portfolio companies, realize that if they are actively involved in these companies they are also in a unique position to improve ESG practices within the company. As a result, many of these funds, like Starboard, ValueAct and Third Point, have dedicated ESG frameworks to help focus on these opportunities. We see many more of them beginning to adopt such practices.

These AESG investors realize that you cannot achieve ESG goals by investing in the “best” ESG companies and excluding the worst. Nor can management teams be expected to blindly embrace ESG pressures, regardless of the effect they will have on shareholder value. Instead, AESG investors analyze ESG issues and opportunities, as well as company finances and operations, to pragmatically develop strategies and practices that advance both ESG and shareholder value or which favor one without hindering the other.

Accordingly, AESG solves problems with ESG investing because (i) it is genuine and not a marketing ploy, (ii) it relies on qualitative analysis, not quantitative metrics and ratings, (iii) it uses engagement to actually effect ESG change without sacrificing shareholder value, and (iv) it has the alpha that has historically been associated with shareholder activism. Moreover, AESG investors are not only looking to change ESG practices in their portfolio companies during their engagement, but also to change the long-term culture of the company so that ESG is embedded in management thinking as something to weigh and consider in all future business decisions. .

ESG investing is a term that combines two concepts: ESG and investing. However, most investment funds on either side of the debate tend to focus on just one of these concepts and ignore the other. Responsible ESG investing means not only being responsible for environmental, social and governance factors, but being a responsible investor for ESG factors and the goal of achieving outsized capital appreciation. This is a fundamental principle of AESG investing.

Because there are a limited number of investors who have the skills, characteristics, and inclination to actively engage in the management of portfolio companies, AESG investment strategies will always be a small subset of aggregated ESG assets. But it will be an increasingly important subset, and those who engage in AESG investing will add a much-needed active component to ESG investing to effect real change and generate real alpha. ESG investing is still a nascent strategy and will continue to grow and evolve. As we see more and more activist managers begin to focus their efforts on ESG improvements, AESG is becoming an important part of this evolution.

Ken Squire is the founder and president of 13D Monitor, an institutional research service on shareholder activism, and he is the founder and portfolio manager of the 13D Activist Fund, a mutual fund that invests in a portfolio of activist investments 13D. Squire is also the creator of the AESG™ investment category, an activist style of investing focused on improving the ESG practices of portfolio companies.