ESG and the Davenport Asset Management Research Process
ESG investing has grown in popularity and influence over the last decade, having reached a size and level of mind share that is impossible to ignore. We have done extensive research in recent years in an attempt to understand the merits of ESG integration and identify ways in which Davenport Asset Management can enhance its research process with its implementation.
Throughout this journey, we have uncovered many inconsistencies and contradictions in the way ESG criteria are defined/implemented. Additionally, we consider ESG performance data to be insufficient, inconclusive and misleadingly marketed in many cases. All of this said, our research suggests that ESG does have the potential to create value as a part of a fundamental manager’s risk management process. We therefore have devised a set of new reports, procedures and organizational enhancements that we believe will improve our research process. Importantly, we believe these updates integrate seamlessly into our current workflow and do not cause any undue distraction or sacrifice of our core values or discipline around fundamental bottoms-up research. Below, we sort through key industry dynamics, terminology, misconceptions and key findings of our research. We conclude with a summary of actions taken and processes adopted:
“ESG” refers to the “Environmental, Social, and Governance” practices of an investment that may have a material impact on the performance of that investment. The integration of ESG factors is used to enhance traditional financial analysis by identifying potential risks and opportunities beyond technical valuations. While there is an overlay of social consciousness, the main objective of ESG valuation remains financial performance.
Examples of ESG factors include:
- Climate change
- Greenhouse Gas (GHG) emissions
- Resource depletion, including water
- Waste and pollution
- Working conditions, including slavery and child labor
- Local communities, including indigenous communities
- Conflict regions
- Health and safety
- Employee relations and diversity
- Executive pay
- Bribery and corruption
- Political lobbying and donations
- Board diversity and structure
- Tax strategy
The Relationship between ESG Factors and Risk Management
ESG is not a replacement for our bottoms up, fundamental research approach. However, there is compelling evidence that consideration of ESG factors can lower the risk profile of a strategy without sacrificing performance. A study from the Morgan Stanley Institute for Sustainable Investing indicated that sustainable funds experienced 20% lower downside deviation than traditional funds. The chart below depicts this phenomenon.
How We Incorporate ESG Factors into Our Research Process
Davenport Asset Management has a partnership with Sustainalytics, a Morningstar company and a global leader in
ESG and Corporate Governance research and ratings. Our subscription gives us access to ESG Risk Ratings for the
Ratings+America Developed universe (3,500 issuers) and Global Large Cap universe (approx. 4,000 issuers).
This platform allows us to enhance our research process in the following ways:
- Reporting: Portfolio and holdings specific reports that give us insight into the current (and historical) ESG ratings and risk factors
- Discussion: Recurring discussion of key ESG developments within our strategies
- Idea Generation: Incorporate ESG reports and analysis into the idea generation process
Our relationship with Sustainalytics should serve to augment an already robust research process focused on quality and risk. Though we do not believe an ESG filter is any sort of secret ingredient to investment success, we do believe that ESG integration can improve our risk management processes and enhance our overall research process by providing a different lens through which we can evaluate businesses and our portfolios.
Past performance is not indicative of future results. Diversification and asset allocation does not ensure a profit or guarantee protection against a loss. There is no guarantee that a company will continue to pay dividends. The statements and opinions expressed in this article are those of Davenport Asset Management as of the date of the article, are subject to rapid change as economic and market conditions dictate, and do not necessarily represent the views of Davenport & Company LLC. This article does not constitute investment advice, is not predictive of future performance, and should not be construed as an offer to sell or a solicitation to buy any security or make an offer where otherwise unlawful. Investing in securities carries risk including the possible loss of principal. Individual circumstances vary.
Source: Morningstar Direct Data as of 07/31/2021 ©2021 Morningstar, Inc. All Rights Reserved. The information contained herein: (1) is proprietary to Morningstar and/ or its content providers; (2) may not be copied or distributed; and (3) is not warranted to be accurate, complete or timely. Neither Morningstar nor its content providers are responsible for any damages or losses arising from any use of this information.