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Once used in just a small corner of the investment world, the practice of integrating Environmental, Social and Governance (ESG) factors into investment decision-making has enjoyed massive growth over the last 30 years. For Onex and its wealth management platform Gluskin Sheff, ESG represents a lens through which to view and assess potential investments.
“ESG integration is focused on evaluating ESG factors through a financial lens; to determine which ESG factors represent real financial risks or opportunities for us and to make sure they’re appropriately considered as part of our investment decision making,” said Judy Cotte, Managing Director, Head of ESG at Onex.
ESG Integration falls under the larger umbrella of Responsible Investing (RI) but is distinct from Socially Responsible Investing (SRI), an approach which typically screens out certain sectors to allow investors to align their investments with their values. It is also different from Impact Investing which focuses on companies whose products or services are helping to solve some of the world’s environmental or social problems.
“Integrating ESG into your investment process is really just part of good investment. It’s making sure that you’re considering not only the core financial metrics that you always considered to determine a company’s outlook, but also making sure you are considering broader ESG factors which might not appear in the financial statements but might have a significant impact on the company’s value,” said Cotte.
In the three decades since the first socially responsible investment index launched in 1990, global ESG assets have grown to US$35 trillion, according to Bloomberg, and are on track to exceed US$50 trillion by 2025.
For many, the environmental aspect of ESG is the one they may think of first, as ESG has become closely associated with green investing issues such as climate change and reducing plastic waste. These are important criteria to be sure, but the ESG umbrella is broader than just those two issues. The environmental aspect of ESG considers the effect of a company’s operations on the environment. This includes carbon emissions, but also how well the company manages risks of events such as oil spills or other disasters, and broader operational concerns such as water usage, waste management and the potential for other environmental issues in the company’s supply chain.
Looking at the other aspects of ESG, social factors generally encompass the company’s approach to its own workforce, as well as the effect a company has on the people and the communities where it operates. This includes the company’s approach to diversity, equity and inclusion, workplace health and safety and respect for workers’ rights, as well as product safety issues.
The governance aspect of ESG is critical for every company, as it covers a company’s internal functioning, including issues such as board quality, executive compensation, business ethics and board oversight of strategy.
As a starting point for their analysis, Onex investment teams reference the standards set by the Sustainability Accounting Standards Board (SASB), which identifies material ESG factors across seventy-seven industries, the guidance set out by the Task Force on Climate-Related Financial Disclosures (TCFD), which provides guidance for consideration and disclosure of climate-related risks and opportunities, and MSCI’s ESG research. These resources, coupled with their own research and investment judgment, can help our investment teams identify ESG-related risk factors in potential investments.
However, Cotte sees no reason an integrated ESG approach must result in a smaller investment universe. Indeed, an ESG analysis can uncover investment and business opportunities. For instance, it can sometimes make sense to invest in a company with some ESG risks if there is the potential to encourage the company to address those risks in a way that will add value over the longer term, says Cotte. An ESG analysis may also uncover opportunities for growth by helping to identify new efficiencies, new products or new ways to appeal to clients or consumers.
That said, Onex does screen out a small number of sectors and investments seen as having the potential to cause significant net harm to society or the environment or which pose unacceptable levels of risk. These exclusions cover tobacco manufacturing, adult entertainment, controversial weapons, automatic or semi-automatic firearms for the civilian market, the mining of thermal coal, the production of palm oil that has not been certified as sustainable, and the operation or management of private prisons.
However, Onex maintains its focus on providing strong returns for its clients, and Cotte says it is a common misconception that adopting responsible investing practices means sacrificing returns.
“To the contrary, to the extent that an ESG factor has potential to impact a company’s financial returns, whether it’s positive or negative, properly considering it is an essential part of good investment decision-making,” she said.
She points to studies that show companies that manage ESG factors well tend to have lower risk, lower cost of capital, better operational performance, and better share prices over time. Additionally, in many markets, particularly in Europe, there is increasing regulatory pressure on companies to more fully disclose their approach to ESG issues and to provide quantitative ESG data. This further enables investors to factor ESG into their valuations.
As part of its commitment to RI, Onex has signed the Principles for Responsible Investment (PRI), a leading collaborative framework for investors committed to ESG and responsible investment and is a participant in the ESG Data Convergence Project, which aims to improve ESG reporting and standardize ESG metrics in the private investment space.
Onex also has a number of ESG initiatives in the works, including the selection of an ESG data collection platform, which will facilitate better collection, monitoring and setting of targets to improve ESG performance measurement in its portfolio companies. Also in the works is a climate strategy that aims to provide a means to understand and account for climate risks across Onex’ portfolios. Onex is also exploring the development of thematic or impact funds for its Gluskin Sheff clients.