Here’s the news of the week – and how we see it here at McAlvany Wealth Management:

Good Citizens Are Good Investments

ESG, or Environmental and Social Governance investing, has become a hot topic in the investment community and corporate boardrooms, as well as in the press. We at MWM are beginning to get many questions on this subject. We will address what ESG is, why we care about it, how we use it in our investment process, and why we do not believe that it is a fad. Instead, we see it as a long-term trend that is important for us to pay attention to as it has implications for both investment results and society at large.

There are three key elements in the realm of the ESG acronym. First, the E – Environmental. This can run the gamut from waste emissions and toxic waste to land use and carbon emissions. The – Social includes health and safety, as well as human rights. Finally, the G – Governance includes board of directors construction, effectiveness, diversity, pay/performance alignment, and conflicts of interest.

ESG can be hard to measure. There are services that will assign a quantitative ESG score based on numerous factors. While we believe this to be an appropriate tool, it is by no means to be relied upon. It can be somewhat backward looking, to a degree. For us, there can be no substitute for understanding management philosophy and the “tone at the top” around the key issues that comprise ESG so we can see failures before they occur and potentially mitigate risk or at least avoid enabling poor corporate citizenship. We can think of so many examples and case studies of companies that did not focus on ESG, which adversely affected shareholders and investment returns.

These issues are often industry-specific, and incidents are often something to be learned from. For example, mining has seen numerous examples of environmental failures such as tailings dam failures, social failures such as demonstrations and blockades at mine sites, and governance failures such as a gross mismatch between investor outcomes and management compensation. Studying particular incidents and asking ourselves, as well as our contacts within a given industry, how these things could have been avoided often provides clues as to how we should structure questions around these topics for future investments.

As one of a host of examples, a tailings dam failure might cause us to critically about the implications for a junior company with relatively limited resources for design and construction of such a facility. We might ask what alternate designs have been studied, and have questions as to what trade offs have been made. As it pertains to social issues, we have found that asking questions regarding best practices of companies who have operated successfully in very challenging jurisdictions has provided outstanding context. We might ask them when and how they started their process in community engagement. Good stewards will take enormous pride in addressing the needs of the community for long after the mine life has depleted, and show you the infrastructure, schools, and roads they have built, as well as the jobs that have been created. They will share not just how they have addressed water usage for the mine, but perhaps how they have facilitated additional water resources for the community. This is by no means an exhaustive list, but instead should serve as an illustration.

Fundamentally, the best companies take fiduciary responsibility as seriously as we do, and we can look to those who “score” well, and evaluate what they are doing right. We do not see a one-size-fits-all approach to evaluating environmental and social issues for an investment or industry, and want to understand granularly how key issues are dealt with. Evaluating disclosures is the starting point for engagement with companies on this, not the final word.

Governance is the easiest of the three to observe and quantify, which is likely why it seems to receive the most attention. The failings of governance can often be spectacular. Enron was a pure failure of governance as it is clear that, in retrospect, the board was comprised of enabling sycophants. We applaud those who aim for true diversity of opinion, age, gender, race, and other factors throughout their organization and boards, and take the time to build a board with a skill set appropriate for the challenges and opportunities that face the future of the business climate and one that is built specifically in the interest of healthy debate and dialog.

It is clear that addressing ESG concerns factors in to financial and stock price performance. Fundamentally, we do not believe that there is necessarily a trade-off between investment returns and adopting ESG into analysis and investment decision making. In fact, quite the contrary – it is clear that ignoring ESG will ultimately affect investment performance negatively and cause fiduciary failure. We believe that, ultimately, attention to ESG issues is simply best practice for all long-term investors.

Best Regards,

David McAlvany
Chief Executive Officer
MWM LLC