How ESG Metrics Work And Why All Investors Should Care

Summary

In this episode of "The Conscious Investor," Martin Kremenstein, head of retirement and ETF solutions at Nuveen, discusses the importance and utility of ESG (Environmental, Social, and Governance) metrics. ESG provides a framework for evaluating companies based not on finances but on their social responsibilities and ethical practices. While beneficial in assessing company practices compared to peers, ESG metrics can fall short by not capturing a company's overall mission and the varied importance placed on different aspects by investors. Although primarily self-reported, ESG data is essential for identifying well-run companies and aids investors in aligning their investments with social values without necessarily sacrificing returns.

Highlights

• Martin Kremenstein explains the value of ESG metrics in assessing companies beyond financials — focusing on environmental, social, and governance factors. 📊
• ESG metrics combine self-reported data and analyst evaluations, providing varied insights into company practices. 🤝
• Investors can align their portfolios with personal values using ESG strategies, identifying companies known for ethical practices. 💰
• Self-reported ESG data primarily benefits larger companies, though it's accessible down the cap structure and globally. 🌐
• The varied importance of ESG factors requires investor focus to align ethical values with investment choices. 🧩

Key Takeaways

• ESG metrics are vital for evaluating companies based on environmental, social, and governance aspects without focusing on their balance sheets. 🌍
• Investors can match their portfolios with their values using ESG ratings, providing an ethical investment path without losing returns. 📈
• Diverse perspectives on which ESG factors matter most require investors to prioritize their values when choosing investments. 🔍
• ESG metrics are a powerful risk management tool, helping investors avoid companies prone to scandals or poor management. 🚫
• Divesting can align investor values with ethics but also removes potential influence over company practices. 🌱

Overview

Martin Kremenstein, head of retirement and ETF solutions at Nuveen, dives into ESG metrics, outlining their significance in evaluating companies. ESG, short for Environmental, Social, and Governance, gives investors a way to assess company behavior concerning the planet and society, beyond just the financials. This approach helps investors make decisions aligned with their ethics, while also offering insights into corporate citizenship.

The strength of ESG metrics lies in their ability to highlight the differences in corporate social responsibility. However, their subjective nature means that what's important to one investor might not be the same to another. From environmental stewardship to fair social practices and robust governance frameworks, ESG metrics demand investors to prioritize what aspects align with their values.

One key takeaway from Kremenstein’s insights is that aligning investments with personal values doesn’t mean sacrificing returns. In fact, ESG frameworks can help identify companies that might otherwise be prone to controversies or mismanagement. This conscious investment strategy allows individuals to impact corporate behavior positively, balancing ethical values with financial goals.

Chapters

• 00:00 - 01:00: Introduction to ESG Metrics The chapter titled 'Introduction to ESG Metrics' features a discussion with Martin Kremen Stein, head of retirement and ETF Solutions at Nuveen, on ESG metrics. ESG stands for Environmental, Social, and Governance, and it serves as a framework for analyzing companies in comparison to their peers based on performance in these areas. Kremen Stein discusses what ESG metrics measure, their effectiveness as measures of social responsibility, and their limitations. Under the environmental category, metrics like water usage are included.
• 01:00 - 02:30: Components of ESG Metrics This chapter discusses the components of ESG (Environmental, Social, Governance) metrics. Environmental metrics focus on waste production and the efficiency of resource management, as well as the company's behavior towards its surrounding environment. Social metrics evaluate the treatment of clients and workers, and include diversity aspects related to management and the workforce. Governance metrics assess the company's leadership structures, such as share class and governance frameworks, to determine how well the company is managed. Overall, ESG metrics provide an integrated perspective on these three areas.
• 02:30 - 03:30: Shortcomings and Flexibility of ESG Metrics The chapter discusses the limitations and advantages of ESG (Environmental, Social, and Governance) metrics in assessing companies. It highlights that while ESG metrics are effective at comparing Company A to Company B in terms of their performance, they are less effective in evaluating a company's overall mission or intent to do good. This presents a challenge in managing and measuring the broader impact of a company's actions on society, beyond what traditional financial assessments offer.
• 03:30 - 04:30: Public Reporting and Analysis of ESG Metrics The chapter titled 'Public Reporting and Analysis of ESG Metrics' discusses the varying importance of different ESG (Environmental, Social, Governance) factors to different people. It highlights that opinions on which aspect is more important can vary widely, emphasizing the challenge in creating a universal ESG framework without needing some compromise. The chapter also touches on the idea of self-reported metrics by companies in their ESG reporting.
• 04:30 - 05:30: Advice for Value-based Investors Chapter on 'Advice for Value-based Investors' discusses how most data used for investment decisions is publicly available. It combines self-reported information and analyses by analysts examining company factsheets and regulatory reports. The chapter notes that larger companies tend to provide more comprehensive reporting, but valuable data can still be accessed across various company sizes and international markets. Additionally, an ESG (Environmental, Social, and Governance) component is mentioned, implying its importance in value-based investing.
• 05:30 - 07:30: Trade-offs in Responsible Investing The chapter discusses the concept of responsible investing, focusing on trade-offs one might encounter. It highlights the importance of understanding large cap, small cap, and emerging markets in both developed and developing regions. It offers advice for individuals who wish to invest according to their values but feel overwhelmed by the vast array of options. The text suggests that these individuals need to first define what is important to them and mentions the existence of various ESG (Environmental, Social, and Governance) providers that can assist in this process.
• 07:30 - 09:30: Divestment Strategies and Their Effectiveness This chapter delves into divestment strategies with a focus on evaluating their effectiveness in the context of Environmental, Social, and Governance (ESG) criteria. The discussion centers around how investors need to decide the specific criteria they are targeting, whether religious, social, or general ESG factors. Companies that excel in sustainability and social responsibility may have frameworks in place that make them better stewards of societal and environmental welfare. ESG funds are easily identifiable as they are labeled with terms like 'ESG,' 'Responsible Investing,' or 'Impact,' signalling their adherence to specific ethical or sustainability standards.
• 09:30 - 11:30: Costs of Socially Responsible Investment The chapter discusses the complexities and considerations involved in socially responsible investing. It emphasizes the importance of understanding how products work and the criteria used to score companies for such investments. The literature provided by funds should clearly explain these aspects. The chapter also suggests that if the information is not clear, investors might consider looking at other providers. Additionally, for those investing through a company's retirement plan, it recommends discussing responsible investing options with the plan manager. A key question posed is whether there is a financial trade-off when investing responsibly, as traditionally, it was believed that you had to sacrifice financial returns to invest ethically.
• 11:30 - 13:30: Smart Beta and Quality Factors in ESG The chapter discusses the role of Smart Beta and Quality Factors in ESG investing. It highlights that using an ESG framework can help investors avoid companies with poor practices. The Equifax scandal is cited as an example, noting that Equifax had been downgraded by major ESG data providers due to data privacy and security issues well before the scandal became public. Additionally, Facebook was not included in a large-cap growth ETF due to its poor scoring in this context.
• 13:30 - 15:00: Risk Management Benefits of ESG Frameworks The chapter 'Risk Management Benefits of ESG Frameworks' highlights the growing importance of data privacy within the Environmental, Social, and Governance (ESG) frameworks. It underscores how data privacy has become a critical concern, particularly for tech companies. Notably, data privacy is often encompassed under the social criteria in ESG assessments. The chapter uses the example of Facebook, which has faced divestment issues due to data privacy concerns, to illustrate its significance. Additionally, it mentions the use of MSCI as a data provider for scoring companies on various ESG criteria, including data privacy.

How ESG Metrics Work And Why All Investors Should Care Transcription

• 00:00 - 00:30 this is the conscious investor presented by Devine I'm here with Martin kremen Stein the head of retirement and ETF solutions at Nuveen can you talk to me about the ESG metrics and what do they measure and how good are they of measures of social responsibility and where do they fall short sure sir ESG stands for environmental social and governance and what that really is is a framework for analyzing companies and really assessing how are they compared to their peers in terms of performance against these metrics under II you have for environmental you have a water usage
• 00:30 - 01:00 waste production and general kind of environmental behavior about how efficient they are and managing their resources and also looking after the environment around them under social it's around how well they treat their clients how well do they treat their workers and then there also some diversity aspects around the the management and workforce and then under governance I mean that's around share class structure and governance structure within the company how well-run is the company when you take it all together what you're really looking at is another
• 01:00 - 01:30 way of assessing a company without looking at its balance sheet and looking at how it impacts the broader broader society at large and where do these do a really good job and where do you think that they they fall a little short what can't they measure sure so I think when they do it they do a good job in terms of how well is Company a doing compared to Company B but it's less good I think you're looking at what is the overall mission of a company in terms of is it out let's do good and if so how do you how do you manage that I think the other way where it kind of Falls a little bit
• 01:30 - 02:00 short is that it's it's a little bit of a framework so lots of people have different views around what is more important for some people it's around environmental that's more important but others it's social for others it's governance you know as many people as there are in a room there are going to be different opinions as to what actually is important and so unless you are gonna go and build a bespoke portfolio for someone in a separately managed account there's gonna be have some to have to be some degree of compromise around how that ESG framework is actually going to be applied and are they self-reported our company is tell
• 02:00 - 02:30 its sharing these metrics with you with I mean with investors at large yeah so most of the data is public it's a combination of self-reported and also analysis done by you know analysts who are pouring out company factsheets you know their regulatory reporting and so forth so because of that you do tend to get better reporting from larger companies but you can get reporting for companies all the way down the cap structure cap size and also internationally as well you know we're able to produce an ESG
• 02:30 - 03:00 framework that enables you to look at large cap value as well as small cap but also emerging markets in developed markets as well and do you have advice for people who want to invest along their values and who maybe haven't spent a lot of time looking at the ESG metrics what is some way to get them over the hurdle where it feels like there's just too many options and they they want to put their money where their values are sure so I think there are a couple of things first of all they are gonna have to define for themselves what what's important to them and you know there are certain ESG providers that have a very
• 03:00 - 03:30 specific slant to how they're doing it and they have to decide whether that's what they're looking for whether it's based on religious or certain other social aspects if they're looking for just general you know ESG and in terms of framework for companies that are better stewards of their you know the environment and social then you really they should either look for ESG providers there are certain companies that have been in this space for a long long time and and all ESG funds will be labeled ESG or responsible investing or impact because you know if you have any SG fund you are gonna put that in the name somewhere and then you need to look
• 03:30 - 04:00 at how the products work you know look at the the criteria by which companies are being scored that should be very very clear and apparent within the funds literature if it is and maybe then move on to another provider if you're looking at your retirement plan maybe talk to whoever runs your company's retirement plan are some about responsible investing options for that plan is there a trade-off do you feel like that you can still make money and reverse investment responsibly so historically the Nok has been that to actually have responsible investing you had to give up
• 04:00 - 04:30 some performance I think we're seeing now that that isn't the case and we're actually seeing you know lots of times we're using an ESG framework can actually help you avoid companies with bad practices and for example we had the Equifax scandal sometime last year right or Equifax had actually been downgraded by major ESG data providers over data privacy and security issues about 18 months to two years beforehand you know within our large-cap growth ETF Facebook hadn't been included because it's called relatively poorly compared
• 04:30 - 05:00 to other tech companies over data privacy concerns that was not something that I ever considered as part of the ESG framework is data privacy but it's very important to a lot of people a lot of people are divesting for Facebook now how how does that metric work in yes gee so you know when you're looking at a common data provider score in the company so we use MSCI is our data provider when they score the company they score it based on all the different you know criteria and under social data privacy is in there but also when you're looking at
• 05:00 - 05:30 controversial business practices which is another another way of scoring companies you look at things that could be controversial and so the data privacy thing had come up from the I think that 2014 kind of conversation Facebook had with the government so that was something was always on the radar and so Facebook doesn't have a particularly bad ESG score on absolute terms but compared to the rest of the tech sector which tends to do better it's called relatively poorly so within our large cap growth ETF right it's called poorly in tech it didn't make the cutoff for text we didn't have it in
• 05:30 - 06:00 there so you know last year as Facebook did quite well our performance suffered this year without Facebook in that our performance has done quite well and divesting seems to be one way in which a lot of people want to express their values is that something that you're seeing is is and how effective is divesting as a method of making a difference so divestment is one tactic you can use I think you know we have certain industries where we do diverse from so weapons manufacturers alcohol gambling tobacco and then nuclear power however
• 06:00 - 06:30 you know those are industries that we feel that like they're essentially they're putting thats in stock basket and so we divest beyond that I think if you are just doing straight divesting what you are doing is taking yourself out of the conversation with with the the company with the issue of the stock for example if you were to divest from energy companies you couldn't actually be in a conversation with them as a major shareholder encouraging them to look at say renewables right so you need to kind of weigh up diverse from which is our I feel good cuz I'm not invested
• 06:30 - 07:00 in what I think is a sin stock versus well I have no say in trying to influence that company's behavior so it can be a little bit self-defeating because you've now moved yourself from that conversation with the company and how much does it cost to be a good to be a socially responsible investor our fees higher on socially responsible investment products not particularly I mean we pray sorry rets somewhere between the straight kind of market cap way too benchmarked and you know smart beta and when you look at how we're scoring the companies someone said
• 07:00 - 07:30 to me was very much like non-financial quality factors you can look at ESG is almost like a smart beta overlay particularly when you consider the risk management aspects of it you know we actually put together a series of portfolios using all the building blocks within our s GTF suite and it came in most of the time under 30 basis points so you think investors can actually you know invest according to their beliefs without paying over the odds to do so and can you talk about that a little bit like the smart beta and the benefit from investing from not investing in things
• 07:30 - 08:00 like Facebook what was so if you think about the factors themselves they are effectively how well-run is the company so you're looking at quality factors right and quality is one of the more nebulous of the smart beta major factors and so you could say well actually this is just another way of defining quality in the company right does it waste resources does it look after its customers and get it stay out of trouble with the regulators and you know does it have a decent management structure that encourages accountability and so by having that framework in place you're able to avoid companies like
• 08:00 - 08:30 Volkswagen BP before the Deepwater Horizon incident had actually been downgraded and removed from major ESG indices over concerns about its outsourcing of maintenance of offshore oil wells right which is precisely what happened there so it's really a very very good risk management tool and you know MSC a do research and I think they found that companies in the bottom 10% for ESG score had a much much higher likelihood of what they deemed to be a catastrophic or a material drop in share
• 08:30 - 09:00 price from from a from an incident and by material they were talking ninety percent and so you know by by actually having this framework in place you are really putting in place a a method for trying to avoid tail risk from companies that are badly run and may end up having serious serious scandals in the press you [Music] you