To ESG or Not to ESG?

You have to look really hard for any professional investor who hasn’t heard of ESG these days. So, should all investors do ESG?

To answer this question, I want to un-flatten it first.

Let’s use Value investing as an analogy.

Should all investors do Value Investing?

  • Some would say ‘absolutely’ and invest using an explicitly value-based approach. But which one? Deep value, relative value, DCF, quant value, intangible value. Any two fundamental analysts will end up with different valuations. Any two quants will end up with a different set of value rankings. Any two activist investors will value a firm differently based on how they plan to engage with it.

  • Even if you are a growth investor, you still take into consideration some notion of value. If you are multi-factor quant, you add momentum and value together. We can even say that value investing can be done without looking at the fundamentals at all, and solely be price-based mean-reversion, such as what quants use for value factors in currencies and commodities. Or how about mean-reversion based stat-arb - is that still value investing? Can we say that any converging strategy is value investing?

  • So, are most investors Value investors? Even if many such investors would not self-identify as value investors?

Should all investors do ESG?

  • If you consider SASB’s definition alone, just like value investing, it becomes clear how pervasive and diverse it is. For example, ‘Business Ethics’, ‘Business Model Resilience’, ‘Competitive Behavior’, ‘Systematic Risk Management’ and ‘Employee Engagement’ - all sound like elements of Warren Buffett’s investment process.

  • Outside of the SASB list, you can find numerous other ESG-related factors that affected companies, anything from organic food and electric cars to oil spills, wild fires, data security and opioids.

  • Traditional fundamental and quantitative analysis has already been picking up all sorts of ESG issues but indirectly, through changes in prices, fundamentals and sentiment. Doesn’t it make sense to focus on the underlying drivers more explicitly?

  • Just like value is part of most investing styles out there, some form of ESG is already part of most company’s fundamental realities. So far as investors, we have been measuring ESG indirectly but as the data availability grows, we can now look better ‘under the hood’ and try to measure the material factors more directly.

  • Even if you decide to bet against ‘Business Ethics’, ‘Business Model Resilience’, ‘Competitive Behavior’, ‘Systematic Risk Management’ and ‘Employee Engagement’ (most likely based on some notion of Value), you still would be better off ‘doing ESG’ to strengthen your mean-reversion thesis (to avoid the value traps).