Investment funds with a focus on Environmental, Social and Governance (ESG) concerns have become increasingly popular over the past few years as shareholders have begun to pay greater attention to the impact their investments have on society as a whole.
It is perfectly understandable, and indeed commendable, that investors seek to invest in companies that try to have a positive impact on the world. At the same time, the idea that companies which are ESG-compliant also represent better investments and outperform broader stock market indexes has also begun to gain traction. The basic pitch is that companies and their shareholders can do well, by doing right.
This is certainly an appealing argument, although in truth it is hard to verify the validity of this outperformance argument for several reasons. First, the definition of ESG can be somewhat subjective depending on which ESG factors are being evaluated. For example, a company may score well on the environmental front, but have relatively poor governance. Is it really possible to quantify all of the variables that are potentially included in an ESG score in a manner that will consistently lead to stock market outperformance? Second, it is difficult to determine if ESG-related outperformance is attributable to companies actually behaving in an ESG-compliant manner versus such companies being able to attract incremental investment dollars as a result of obtaining a good ESG score. Many analysts suggest that ESG outperformance may simply be a self-fulfilling prophecy.
Our belief at Bridgeport is that a more nuanced view of ESG is appropriate. When a company takes care of all of its stakeholders (customers, employees, communities, the environment and owners), it seems reasonable to assume it will fundamentally perform better over the long term and will likely be in a better position to manage the various risks it faces. This can generate a more sustainable and resilient business model, allowing for a higher valuation. It is hard to say whether these advantages will consistently yield short-term outperformance, but we believe they can deliver above-average long-term returns.
We are less confident in the idea that a formulaic ESG scoring and ranking process — which underpins many ESG funds in the market — can add any real excess value. These approaches generally deal with incomplete information or make blanket assumptions about the importance of different variables. Sadly, much of the ESG movement can be boiled down to marketing and little else.
At Bridgeport, we are always on the lookout for situations where ESG-related factors are helping — or hurting — a company’s long-term prospects. Consider, for example, our position in General Motors (GM), a company widely ignored by systematic ESG funds because its automobiles harm the environment. However, we view GM’s ESG profile differently. It is one of only a handful S&P500 companies that is led by a woman (Mary Barra has been CEO since 2014). The company and its supply chain pay above-average wages and benefits in less affluent communities. And, while GM’s current auto production is a large contributor to carbon emissions, the company has a credible plan for converting its business to 100% electric vehicles by 2035, which actually makes them part of the climate change solution.
In sum, we are of the opinion that because GM operates with a tremendous amount of regard for all its stakeholders, it is an excellent example of an ESG leader. This is a view not shared by standardized ratings systems that fail to look past the pollution-generating industry in which GM operates. For example, Morningstar’s “Sustainalytics” system ranks GM as a “high-risk” entity, thereby precluding it from any fund that uses these ratings as their benchmark for inclusion. We prefer the approach Forbes magazine has taken with its total stakeholder analysis, which ranks GM as #28 overall and #1 in the auto industry for companies that are “doing right by America”. We are confident that their efforts will be recognized and rewarded in time, allowing us to benefit as shareholders.