ESG (Environmental, Social and Governance) investing is a relatively new acronym for an investing process that has been around since at least the 1970s. Previous efforts of these methods have included the descriptives SRI (Socially Responsible Investing) or Sustainable Investing. We at TCV are happy to see the evolution to ESG, which we think blends the goals of these former reiterations with the basic fundamentals of investing that we have always embraced.
ESG is simply the disciplined application of specific non-financial criteria to the evaluation and analysis of potential equity investment opportunities. ESG isn’t about simply applying limits or exclusions to portfolios and their construction; i.e. we once were asked to exclude companies that did business in South Africa. Instead, investing using the ESG process is about trying to capture issues, risks and opportunities of companies beyond that reflected in balance sheets and income statements.
TCV has contracted with Institutional Shareholder Services (ISS) to provide us with their sophisticated screening and data analytics with respect to ESG. Our environmental screens take into account such areas as climate change policies, toxic emissions and environmental disclosures. Social issues flagged and identified include work force diversity, human rights policies, and work force and employee relations. Lastly, governance evaluations include board independence, management compensation, and financial reporting policies. We use this data two ways: First, we run our entire equity approved list against this data base; the result is a raw ESG data score between one and 100 (100 being best). More importantly, it identifies key areas of concern for further evaluation and investigation. Second, we then use these rankings to create our own TCV ESG Model Portfolio; only allowing companies that have scored in the top 30% of the rankings to be considered for portfolio inclusion.
TCV ESG Model Portfolio
In addition, having portfolio components that have scored highly on our ESG screening process, our TCV ESG model portfolio has several other important attributes. First, as with all the investments on our approved list, we had to also be comfortable with the financial status and fundamental outlook of the companies. Second, we removed from the portfolio companies that were involved in tobacco, nuclear energy generation, pharmaceutical manufacturing, defense contracting, firearms and fossil fuel exploration and production. The result is a portfolio that is made up of 31 issues (including one Exchange Traded Fund (ETF) that invests in alternative energy), diversified among nine different economic sectors. We do believe that these companies:
- Are leaders in their respective industries
- Are forward-thinking in developing their business strategies
- Meet high positive standards of corporate responsibility
- Are truly focused on the long term
What we don’t believe is that we should have to give up potential investment returns in order to have a portfolio that is made up of fundamentally good investment opportunities married with good corporate behavior. It’s obvious to us that companies that behave properly with respect to environmental, social and governance issues possess more of the characteristics for long term success than those that don’t. We of course recognize that no one, no company, nor ourselves is perfect with respect to these processes or goals. However, as George Will said, “the pursuit of perfection often impedes improvement”, and it’s this improvement in this process that we’ll continue to strive for.