Sponsored by Calvert Research and Management
John Streur, President & CEO
Calvert Research and Management
How does Calvert analyze, assess and address ESG risk?
The first step which is very important to us is to identify the exposure (s) that matter most to the company. For example, a company that's in the business of construction or manufacturing, has a lot of exposure to environmental risk. A financial company’s biggest exposure is probably it’s people which from an ESG perspective, we call human capital management. It is very important for us as investors, to understand how well those companies are managing their risk exposure.
After, we identify the specific area of exposure that's most important to a specific company or a group of companies. We then study the company's history, it’s policies and procedures for dealing with those risks taking into account the issues that accompany their exposure. We may ask what is the company's history of carbon emissions, water use, pollution, product quality or human capital management? What are its policies? We also examine how well the company is actually implementing what's happening day-to-day. How is the company faring in terms of achieving its goals? What we are looking for and the reason we're doing our research is to find companies that are doing a good job managing their core business, products and services while doing a great job managing their material ESG risk exposures. We don't want one without the other. We want both. This is important.
Calvert has been providing ESG research for four decades, how has ESG investing evolved?
The most substantial and significant change that has the biggest effect on research and investment outcomes is actually what companies are doing themselves. Over the course of the past five years, and certainly over the course of the past couple of years, more and more companies, have come to measure and manage their ESG risks. We have seen significant change in terms of how companies are measuring, managing and disclosing information around their ESG risks and opportunities. That's the biggest change.
Will companies that follow ESG principles come out stronger after the crisis?
ESG companies that do well during this crisis are going to have the potential to improve their brand and corporate reputation which will result in elevating their market position and competitiveness. As we navigate the crisis, they will come out ahead on the other end. Companies that do well in managing their employees, and their material risk exposures, are in a better position to manage through this crisis than others. I think that is intuitive; it makes a lot of sense. As a result, a company that has done a thoughtful job of understanding its non-financial material ESG risks, is much more likely to do well going through a crisis period than a company that lags in terms of these risks.
There are some specific things that we can look at such as how a company is creating safety and well-being for its employees, how it is making decisions about furloughs or layoffs, and how a company is providing its products and services to the marketplace during this very high-risk period. You learn much more about management by how it operates in a crisis. You can learn more about management’s style in one year of a crisis than you can learn in a decade of a normal business environment. Companies that were prepared for dealing with their risk exposure, even if they weren't prepared for dealing with a pandemic specifically, seem to be doing well in this difficult period. It has served to strengthen their brand and corporate reputation.
Can you discuss financial materiality in the context of ESG research?
The concept of financial materiality is fairly straightforward. Does the activity or the exposure matter to the company from a financial perspective? What's really interesting and important is that this changes over time. Imagine if 20 years ago, you and I were talking and I said, "Greenhouse gas emissions, carbon exposure, that's a financially material issue to a company," you'd say, "What are you talking about? I don't even know what that means." The point that I want to make here is that issues that are important to us as responsible investors have to be forward-thinking. In other words, these are long-term issues and we have to look at trends that we're confident in, assess current behaviors to decide what will matter to the company from a financially material perspective today and in the future. As investors, we need to think forward. We need to think long-term.
The concept of financial materiality is to understand whether the behavior of a company is likely to be financially material to that company's long-term value creation to the extent that a company treats its employees poorly, we would say that is a potentially financially material issue. The company may have high turnover, may have low productivity, unhappy people, etc. That's financially material. To the extent that a company is creating pollution or its products are unsafe, those are potentially financially material to a business. They face increased costs, they might have regulatory fines, etc.
Clearly, issues that are financially material today were things that a small number of people were concerned about 10 years ago. And over time, the issue became a bigger issue or the rest of the world caught on to it and it became financially material today.
This pandemic is an amazing example of that. For some period of time, credible experts have said if we have a novel illness, it's going to travel around the world pretty quick because we are now globally linked. The pandemic is a financially material ESG risk, right? We focus in on key issues of how a company is impacting the environment, treating its people and employees, all of which matter to the company financially, now and in the future. A lot of these are emerging issues that the entire market may not recognize today but that we are confident will become bigger issues over the long term.
Are there particular industries that are doing a good job at adopting ESG principles?
That's a fascinating question and there are-- each is different. Each industry has a different profile with a different sort of footprint. We have found that companies with high exposure to a specific environmental or social factor seem to be doing a better job at managing risk as they only have to overcome a single exposure instead of managing multiple. It doesn't mean those are attractive investments.
There are some risks that you can only manage to a point and then there's nothing you can do. Fossil fuel is a great example. The oil companies do their best at managing that risk but the risk cannot be managed away. The risk of burning carbon, can't be managed away.
It's counterintuitive but we find that the technology sector, including information technology have done a particularly good job in managing their material ESG risks. In semiconductor manufacturing, the use of water is an important part of the manufacturing process. These companies do an excellent job managing that risk. Human capital is also very important in the IT space. Most of the large successful IT companies do a good job managing their employees.
The finance sector is interesting as human capital is very important, however, the sector has historically lagged in terms of diversity and inclusion. We are now seeing a lot of companies taking initiative and attempting to make real steps to improve diversity and inclusion in their workforce.
There is real momentum. Companies are really on the move as they work to strengthen their positions through better management of ESG exposures. There's a lot of change happening which is why research is so important. We look across sectors and industries. We can point to companies that have done a good job managing significant risks. We could also point to entire sectors that need to improve as well. It’s really a company-by-company analysis. Some of the most successful and largest companies are in that position because they have tended to do a good job managing their material risks.
With greenhouse gas declining due to COVID-19, what is the impact on the climate change?
I want to draw a parallel in terms of humans' ability to deal with risk, particularly a pandemic such as COVID-19 and climate change. We can look back, whether it's over the 50 years since the first earth day, or whether it's during the period from the 1980s when we first began to have committees meet to discuss global warming and climate change. It's been a long time and a lot has been said and done in terms of creating research around climate change. Most people today realize this is a problem. However, we've been able to do little in terms of really changing the metrics and changing the dynamics around carbon emissions. Maybe we've slowed the growth, but we certainly are not where we need to be according to scientific evidence.
Climate change is something that humans have a very difficult time dealing with because it is something that's going to happen in the future. It's not hitting you today. Yet, all of us know that it's a problem, but we've never experienced it. We don't know what the problem will really be like. We read about it, we research it, but because we don't really have the experience of dealing with the problem, we're just having a tough time getting on top of it.
Credible experts have been warning us about the risk of a global pandemic, in which viruses mutate from animals to humans, for a considerable period of time. Last July, FEMA issued a very detailed report about the massive risk of a pandemic and its devastating impact on the economy. Nothing was done about it.
It is the same situation with climate change. Scientific evidence has proven the risk is real. Experts have been warning us, nonetheless, we've had a hard time preparing for it and managing how to prevent it. The big difference is that the pandemic will get under control and eventually subside. We don't know when. Could be one year. It could be three years. But at some point, we're going to be able to adjust, get a vaccine, enough testing to mitigate exposure so it will eventually subside. Climate change is totally different. Once we've gone too far, it will be very, very difficult to solve the physical problems quickly making it become an even bigger risk than what we're experiencing now.
We believe that a result of living through the pandemic, humans now have absolute proof positive that a non-financial risk like COVID-19 can have an enormous effect on our economic health and well-being. We are very hopeful that we'll be able to translate that into better action on climate change. Behavioral finance tells us these are tough risks to deal with in any circumstance. You could also say that COVID-19 proves that we can make hard changes and deal with things that we didn’t think we could. We still have a hard time changing behavior in front of a bad outcome.
The views expressed are those of John Streur and are current only through May 2020. These views are subject to change at any time based upon market or other conditions, and Calvert disclaims any responsibility to update such views. These views may not be relied upon as investment advice and, because investment decisions for Calvert are based on many factors, may not be relied upon as an indication of trading intent on behalf of Calvert. The discussion herein is general in nature and is provided for informational purposes only. There is no guarantee as to its accuracy or completeness.