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ESG From the Practitioner Point of View

  • By: admin
  • On: 11/03/2022 11:59:01
  • In: News
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By Ricardo Daley, Victory Capital Management

Environmental, Social and Governance (ESG) investing has gained immense popularity in the last few years, and there is a good likelihood the practice will continue to see rapid adoption in the future. For practitioners of ESG investing, the challenge of doing good and doing well often relies on an old routine.

This is an excerpt from NCPERS Fall 2022 issue of PERSist, originally published October 13, 2022.
Active portfolio managers who consider ESG and/or responsible investing principles, while also seeking to produce alpha, should start by getting the fundamentals down. This is especially the case for small cap managers.

Quality and the Role of Rating Agencies

From the perspective of THB Asset Management, a Victory Capital Investment Franchise (THB), the process should start with a focus on quality, which is typically revealed by fundamental security analysis.

Some managers, however, may delegate the ESG component of their research to third party rating agencies. But layering an ESG rating screen atop current investment processes may be imprecise. ESG ratings are somewhat subjective and rife with inconsistency.

For example, some rating agencies include controversies (e.g., bad behavior of management) in a rating. Others don't. They may disclose controversies, but they won't impact their rating.

Rating agencies don't produce consistent ESG scores because data collection processes are different from agency to agency. How they analyze data is also dissimilar. And the resources they devote to any individual company can often be constrained. The three big rating agencies are, after all, for-profit businesses.

An example of rating inconsistency is revealed by how often the agencies agree. Each offers an A rating to a host of companies. But within that universe, only 16 percent share the same rating from all three providers.

There is also the fact that not all public companies get rated. For example, MSCI covers nearly all of the S&P 500 companies. That rating coverage applies to about two-thirds of Russell small-cap companies and slightly more than a quarter of the Russell micro-cap universe.

This creates opportunities for active portfolio managers.

A Holistic Approach to ESG

Rating agencies rely on compliance. And compliance can be expensive. A public company's ability to marshal the human and financial resources to compile information required by an ESG rating agency can have a meaningful impact on that company's ability to garner a favorable ESG score.

From the portfolio manager's perspective, relying solely on published ESG ratings filters out many small companies for whom compliance might be burdensome. A small company (even one with $1 billion in capital) that doesn't report to any of the agencies, may get overlooked or under-rated.

So, it is important for portfolio managers to maintain an active approach and engage with companies to explain what information they are looking for and why it's important in their investment decision-making process.

In this way, portfolio managers need to take a holistic approach to ESG.

The takeaway for portfolio managers is to not look at any given data point as purely black or white. There is plenty to be missed in the broader picture. Without delving deeper into the circumstances around a catalyst, managers might miss a very reasonable explanation for why an ESG issue exists. So, it's possible to miss how a company's management is addressing it.

ESG issues are not always black or white. There are myriad shades of gray that can reveal much more about a company than any single data point suggests.

Importantly, missing the shades of gray can constrain alpha for clients. This is especially the case with small cap companies.

To learn more, we invite you to listen in to this podcast as Chief Investment Officer of THB Asset Management, Chris Cuesta, talks about investing with purpose.

Disclaimer: All investments carry a certain degree of risk including the possible loss of principal, and an investment should be made with an understanding of the risks involved with owning a particular security or asset class. Interested parties are strongly encouraged to seek advice from qualified tax and financial experts regarding the best options for your particular circumstances.

Ricardo Daley, MBA is an associate of institutional markets for Victory Capital Management. In this role, he is primarily responsible for client reporting and servicing. Additionally, Mr. Daley will manage relationships and direct sales.

Prior to joining Victory Capital in 2021, Mr. Daley worked at Equity Trust, where he was a Qualified Plan Consultant. He also has experience in wealth management having worked as a financial advisor for Merrill Lynch and Waddell & Reed as well as a Senior Investment Consultant within the former High Net Worth group at USAA.

Mr. Daley earned a B.A. in Business Administration and Accounting from Thiel College and an MBA in Finance from the Keller Graduate School of Management.  He is currently a member of the Thiel College Board of Trustees, serving as Chair of the Investment & Finance committee.  He holds the FINRA series 7 & 63 licenses.



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