Are you unintentionally creating a toxic workplace?
Toxicity often starts when talk diverges from action. Learn diagnostic questions to reconcile lived experience with strategy and improve outcomes...
Brain Circuits
Putting the ‘G’ in ESG (and the ‘A’ in alpha)
The governance aspect of ESG is a fundamental driver of environmental and social quality, but identifying companies characterized by good governance is a hard trick to pull off. Take this simple quiz to see if you know your ‘G’ from your ‘Oh gee!’
1. What’s the best way to understand a firm’s ESG position?
A. Using its ESG disclosures.
B. Using third-party ESG ratings.
C. Conducting bottom-up research on the company.
Answer: (C).
(A) is not a good way to obtain information, because such documents are not legally binding, non-standardized, hard to verify, and often incomplete. (B) does not lead to quality ESG insights, either. Such ratings are often contradictory, require great effort from investment managers to interpret, and do not lead to consistent and significant alpha. By contrast, (C) leads to a first-hand understanding of a company’s ESG position, providing the necessary insights for investment, monitoring, and active engagement.
2. Many investment firms struggle to use ESG analysis to generate alpha in their investment decisions. Why?
A. It’s difficult to distinguish between firms that merely provide ESG disclosure and others that truly practice what they preach.
B. Assigning a monetary value to ESG issues is computationally difficult.
C. The traditional methodology used tends to focus on the output rather than on the driver.
Answer: All of the above.
Boutique investment firms typically do not have the resources to cover a sufficient number of companies for effective diversification, while assigning a monetary value to ESG issues yields questionable results. And focusing on the output rather than the driver risks capturing a status rather than a dynamic: a firm may have a low carbon footprint simply because of its business model, rather than the active will of the board.
3. What’s the optimum way to approach governance from an investment point of view?
A. From a technical and mechanical perspective, using hard criteria such as number of independent directors, and size and diversity of board and management.
B. By understanding firms’ compensation and ownership structures.
C. By understanding what governance actually is.
Answer: (C).
Put simply, governance is the art and structure of decision-making at the top. Assessing it using hard criteria and metrics relating to firms’ compensation and ownership structures risks juxtaposing the three different dimensions of ESG as if there is a tension between them. Good governance drives the long-term orientation, values, and quality of an organization’s resilience and agility in environmental matters as well as in social matters.
Key takeaway
True G drives E and S
The catalyst for a good ESG policy starts with the governance which, in addition to triggering stock outperformance, enhances impactful and transformative environmental and social policies at the corporate level.
Related
Is your legitimacy being questioned? Here’s how to respond
Having your legitimacy questioned can happen to anyone, particularly in novel, tense, or challenging circumstances. Here are three tools to deal with it....
Don’t just do something – sit there!
Leaders are conditioned to leap into action to meet challenges. But what if remaining calm and simply listening is what the people around you need in such moments?...
A trust test for leaders
Trust is foundational in leadership, yet is more of a science than an art. Answer the questions below to assess whether an absence of trust is affecting your leadership. ...