ESG investing is the topic of much conversation lately. It’s become a major force in Institutional investing, which is a big deal for believers in Socially Responsible Investing. Getting large, pooled portfolios such as big endowments, foundations, pensions, and trusts to implement Socially Responsible Investing in their portfolios has been a struggle for decades. ESG is becoming a household name in the finance professional world faster than the retail investor world, however. We hope to do our small part in changing that.

ESG stands for Environment, Social, and Governance. These are the three dimensions that ESG investing hopes to address and measure: the environmental impact of companies; the social policies and influences they have; and the corporate governance policies of the company.

This approach differs markedly from past attempts to use Social Responsibility in investment selection. In the early days of Socially Responsible Investing (SRI), investors were primarily looking to avoid investments that they did not want to profit from personally. It was mostly a process of exclusion of certain investments. The performance of such programs was often called into question, as were the real world impacts. ESG is not a new means of exclusive portfolio building. It’s a means of investigating, scoring, and ranking corporate behaviors across three dimensions with dozens of sub categories. It’s then up to the portfolio builders and managers to decide what is acceptable and what is not.

Chaim Investment Advisors is a proponent of ESG investing. Before we jump into the specifics of what ESG is in this article, we’d like to articulate our stance. We believe that ESG will be the cutting edge of Social Responsibility in the world of finance. ESG offers more measurable and repeatable approaches to judging companies across countries, industries, and asset classes. It gives companies themselves more guidance on what compliance with ESG standards looks like than previous models of SRI were capable of doing.

Something that we struggled with in the past with SRI is that it did not seem to make a difference in the world. A few individual investors choosing to avoid businesses that offend them morally makes sense, and we continue to serve clients with such approaches diligently. As financial planners and investment advisors, however, negative screening for certain, specific business models does not give much guidance to us in terms of how to build and manage portfolios. In our experience, negative screening for companies does not yield the type of portfolios that investors actually want. This or that controversial company ends up getting through the screens; a new industry or business draws the ire of investors quicker than negative screens can respond; negative screens end up filtering only the most obvious abusers, etc.

ESG gives us a toolkit for building and managing portfolios. Some investors only require certain stringencies, and ESG gives us what we need to accomplish that. Other investors are more interested in broader progressive philosophies, and ESG gives us an invaluable set of tools in meeting those needs. It’s clear to us why ESG has won over large, institutional investors and management firms where negative-screen based Socially Responsible approaches never could from a practitioner’s perspective. It’s our belief that ESG is the future of Socially Responsible Investing.

The “E” in ESG stands for Environment. One reason we at Chaim Investment Advisors believe in ESG is that it gives global investors the tools to understand and implement Environmentally Responsibility in their portfolios. It’s important to remember that foreign investors are not just individual households. Foreign investors include the foundations, trusts, and endowments of multinational corporations; they include Sovereign Wealth Funds and National Central Banks; and they include the pensions and retirement savings systems of foreign workers. U.S. investors may even place environmental factors lower on the scale of importance than foreign investors: 86% of South Koreans see climate change as a major threat; only 59% of Americans see climate change as a threat.

ESG looks at numerous Environmental impact subcategories of data:

• Severe Environment Controversies
• Revenue Exposure to Environmental Impact
• Sustainable Impact Solutions
• Weighted Average Carbon Intensity
• Fossil Fuel Reserves
• Numerous Water Stress metrics (including Water Stress High Risk Geography)
• Energy Efficiency
• Alternative Energy
• Green Building
• Pollution Prevention
• Water Sustainability

These metrics can be compared across industry to find stellar opportunities within a specific asset class. They can also be used to compare investments in one country to investments in another as well as comparing companies to the national average within their sector. For investors with globally integrated portfolios, ESG is extremely useful and adaptable for both domestic U.S. investing as well as International investing.

The Social dimension to ESG investing can sound the hardest to define and measure for many investors. To confront the inherently subjective nature of defining Social Impact, most ESG research providers offer analysis and scoring on two dozen or more categories with numerous sub-categories of the Social dimension. We won’t go into all of them, but we will list a few of the most prominent ones:

• Revenue Exposure to Affordable Real Estate
• Revenue Exposure to Nutrition
• Revenue Exposure to Sanitation
• Human Rights Norms Violation OR Watch List
• Severe Human Rights Controversies
• Severe Labor Controversies
• Labor Norms Violation
• Global Compact Compliance Violation
• Sharia Compliance
• Adult Entertainment
• Nuclear Power
• Weapons Involvement

ESG’s Social component gives investors tools to look at not just a headline “Social Responsibility” score, but also look into the details of social impact along any front that might interest them individually. As an example, some investors support Nuclear energy and find it to be socially responsible. ESG gives them the ability to invest positively in companies who utilize it. For those who find Nuclear energy and its utilizers to be unacceptable, investors have tools to exclude them.

Last but not least, the Governance factor of ESG is of matters to investors whether they are aware of it or not. Corporate Governance looks not just at the current consequences of decision makers in an organization, but at the decision makers themselves. We find this tool to be of critical importance, especially when investing Internationally. In some parts of the world, Corporate Governance standards are different from the U.S. ESG gives us as portfolio managers means of building continuity of Governance philosophy into portfolios across regions. If there’s a single factor to ESG that convinced us Chaim Investment Advisors to pursue this philosophy, it is the Governance factor.

Some of the Governance categories looked at by ESG are:

• Governance Controversies
• Lack of Independent Board Majority
• Board Independence
• Board Diversity
• Female Representation on Corporate Boards
• Entrenched Boards
• Shareholder Rights
• Annual Director Elections
• Does Not Use Majority Voting
• Lack of Internal Pay Equity
• Executive Pay Non-Disclosure
• Accounting Red Flags

The Governance component’s importance can hardly be overstated. We believe that Governance is where corporate accountability begins. It’s often where change begins. Looking at who decision makers are and how decisions are made collectively by a company is becoming increasingly important. For investors who demand responsible leadership- not simply agreeable outcomes- Governance matters more than almost anything other factor. After all, it’s in the process of Governance that decisions which are not agreeable to investors are confronted and altered. This includes all aspects of environmental and social impacts. It’s our belief that an investment philosophy that purports to be Socially Responsible that is not looking at Governance is not wholistic and may fall short of investor expectations in the future.

We believe that ESG investing will continue to grow. Given that it is primarily a research process and set of tools, it’s our opinion that competition will increase going forward among research providers. This will benefit investors, as the only way to excel in a competitive environment for research is to offer better information. Chaim Investment Advisors works primarily with MSCI currently for our ESG research. We are often approached by new, competing providers. We see this as very encouraging. We hope to write more about ESG topics in the future; for now, we wanted to give investors an introduction to ESG and our perspective on it. As an investment approach, it has met our clients’ needs better than any other approach thus far, and we look forward to working with increasing specificity in our Environment, Social, and Governance investing approach.