Putting ESG Analytics to Work

Environmental, social, and governance (ESG) criteria have become important considerations for investors globally, and you may have come across increasing use of the term. Several factors are driving the focus on ESG, including:

1. Rising concerns over the impact of climate change and other environmental challenges.
2. The changing demographics of the global investor base, with a new generation of investors expressing a greater interest in corporate stewardship.
3. A growing awareness that integrating ESG factors into the investment process can help generate higher-quality returns.

ESG has myriad of interpretations across the asset management industry, however. Let me define what we mean when we talk about ESG and how we approach it at T. Rowe Price.

Many are familiar with ESG as a specific type of investment, such as a mutual fund focused on socially responsible investing. But we view ESG more broadly—as something that can be integrated into all types of portfolios. We believe that all our investment decisions are better informed when we consider ESG factors alongside financial, industry-related, macroeconomic, and other indicators.

T. Rowe Price’s ESG Capabilities Boosted

Specifically, how does ESG influence our investment decisions? Our efforts are guided by a Responsible Investing team, which uses a proprietary Responsible Investor Indicator Model (RIIM). RIIM evaluates the environmental, social, and ethical profiles of our existing and prospective investments largely using nonfinancial data and incident history—data not traditionally used in mainstream investing. A sample model output looks like this: 

In addition to company-specific research provided through our RIIM analysis, the Responsible Investing team conducts thematic research on environmental and social factors that can influence our investments.

Here are two areas we have recently explored:

1. The Water-Energy-Food Nexus

Water, energy, and food represent the three vital components for sustainable development. The interaction of these factors is commonly referred to as the water-energy-food nexus (WEF-Nexus). Changes in population, urbanization, diets, and economic growth drive demand within each segment—creating complex challenges around the globe.

Insights into the WEF-Nexus provide a valuable lens we can use to better understand the potential impact of environmental dynamics on company performance. When one WEF-Nexus component falls out of balance, knock-on effects can be seen in the other two and the companies that operate within them. I’ve included a snapshot of the WEF sector interaction below.

If you would like to read the full article on this topic and are an institutional investor, click here. All other audiences may read it here.

2. Perspectives on Plastic

The prolific use of plastic, particularly in packaging, is a growing problem for which the world must find a solution—particularly since less than 15% of all plastic produced globally is currently recycled. Sustainability pressures are expected to change the dynamics of plastic consumption with regulation, innovation, consumer preferences, and corporate responsibility all playing pivotal roles in driving this change. 

That said, predictions of plastic’s imminent demise are overstated, in our view. Plastic can be cheap, lightweight, waterproof, and widely adaptable; it is no wonder that it has become integral to modern life. The positive attributes of plastic lead us to believe that the sustainability debate should not ultimately be about “if” we use plastic but “how” we use it and, crucially, how we dispose of it.

Balancing the Demands of Increased Regulation

Regulation is another important focus for investors. Regulators around the world are proposing, and in some cases enacting, new ESG-related regulations. The nature of the proposals varies, with some focused on ESG-labeled products, others on ESG disclosure by companies and/or asset managers, and yet others on mandating the incorporation of considerations such as climate change into the investment process.

Our reaction to these proposals is equally varied. While we believe that some clarity on ESG-labeled products would be helpful, we are concerned about overly prescriptive attempts to embed sustainability factors into the investment process. We believe that sustainability factors must be balanced with financial, economic, and other considerations in any investment decision. Exactly how and where that balance is achieved is specific to each investment and should be left to the discretion of the individual investment managers.

An area where we see the need for improvement is corporate disclosure of environmental and social data. We would like to see increased and more standardized levels of disclosure.

Building Upon T. Rowe Price’s Strong Governance Foundation

We continue to build on a solid foundation of governance and stewardship at T. Rowe Price established over many years. We have remained attentive shareholders, as evidenced by our engagement program and proxy voting diligence.

Improving the transparency of our investment stewardship program was our primary focus in 2018. Most importantly, this transparency helps our clients better understand the thought process behind the decisions we make on their behalf. Meanwhile, the companies we invest in gain insights into how we perceive their governance practices, how we use their ESG disclosures, and how we intend to vote at their next shareholders’ meeting.

Shareholder activism continues to impact all investors—not just the parties involved in a dispute. As such, in June 2018, we felt compelled to make a public statement detailing our perspective on such campaigns—both in terms of the impact on markets where we invest and how we execute our stewardship responsibilities.

Sustainability and a Long-Term Focus Go Hand in Hand

Our fiduciary duty to our clients and a focus on the long term have been the hallmarks of our investment process going back over eight decades and directly to the principles of our founder, Thomas Rowe Price, Jr. In this sense, ESG has always been an important part of our process.

What’s changed over the past few years is our commitment to greater transparency in how we approach ESG. To that end, we recently published our first ESG Annual Report, and I would encourage those interested to click here to read more about our process and the team that is leading our efforts.

Thank you for your interest. I look forward to sharing more on this is a topic in the future.

#esginvesting #esg