ESG in today’s World

Traditionally, investors assessed each of these factors in isolation. Only companies operating in specific industries, such as the energy sector, were deemed relevant for environmental or social evaluation. For the majority of companies, while certain governance norms were accepted, investors considered environmental and social concerns immaterial.

Since then, however, issues like climate change, social inequality and corporate malpractices have forced consumers, corporates and regulators to take action and demand higher standards of E, S and G. Today, many apply the principles of ESG investing across the investment universe. For us, they are an integral part of a comprehensive investment process.

The reason for this is simple. We believe that better ESG practices lead to superior financial outcomes for companies, and ultimately, investors.

ESG work in progress

However, the extent to which investors assimilate ESG into their decision-making processes varies according to region. Europe takes the lead in driving forward the ESG agenda. The UK is pushing ahead its ESG policies, while Japan has made significant strides to improve corporate governance. China is addressing its carbon levels. We await ESG reforms in the US.

Alongside geographic differences, we also find biases at the market-cap level. In our experience, smaller companies tend not to fare as well in ESG ratings as their large-cap peers. This is in part due to the increasingly onerous disclosure requirements. Many smaller companies don’t have the additional resources necessary to prioritize disclosure, particularly if the company is based in a non-English-speaking country.

Further, a greater proportion of small-cap firms are founder-run, which, on paper, can result in weaker governance scores. The reality, though, is often different. Indeed, adequate checks and  balances at the board level, a visionary founder at the helm and "skin in the game" can be transformational for companies. What is the take-home message? Broad-brush ESG box-ticking exercises can misrepresent underlying operations. This is why, in our view, a bottom-up, active investment approach is essential to uncover potential small-cap ESG gems.

There are several key ESG considerations we rely on. We think it is important to evaluate boards, perhaps considering their diversity. We also examine labor management and supply chain oversight. Solid practices in these areas can often support sustainable growth. Scale and innovation are two more factors we consider when looking at a company through an ESG lens. We also consider the opportunity to engage with company leadership to improve ESG management for further improvement, when possible. 

Final thoughts…

Contrary to perceptions, many smaller companies are at the forefront of ESG. However, disclosure can often be weak. Analyst coverage is also usually poor. As investors, part of our role is to engage with management and support positive change. In the end, we all stand to benefit from better ESG.

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