August 13, 2020

Understanding the ESG Portfolio

by Carmen Jeschke

Social consciousness has become a way of life for many. In response, many investment companies have options available to investors that support this philosophy.

Since 1992, Madison Community Foundation fundholders have had the option of aligning their investments with their values by investing in our environmental, social, and governance (ESG) portfolio. The “E” in this acronym is probably the best known and most understood, representing environmental issues like climate change policies and greenhouse gas emissions goals. But that is only one facet of the concept. The social component looks at where a company stands on people-related elements, such as gender; diversity and inclusion; and employee treatment, pay, benefits, and perks. And finally, an ESG strategy looks at corporate governance matters like board composition, proxy access, and transparency in communicating with shareholders.

An Evolution of Socially Responsible Investing

ESG is not a new investing philosophy. It began as socially responsible investing (SRI) in the 1960s, when investors excluded stocks or entire industries from their portfolios based on business activities, such as producing tobacco or support of the South African apartheid regime. Typically, socially responsible investing uses screens or filters to exclude companies and industries based specified value criteria. For example, investors often screened out products and businesses viewed as having a negative effect on life, such as firearms, alcohol, and cigarettes.

Over the years, SRI has evolved into ESG. While the focus remains on public companies, ESG investors actively “opt in” to companies that have impressive environmental, social, and governance attributes. ESG investing offers more flexibility, and involves in-depth research into the nuts and bolts of a company. Investors seek companies that are transparent about their operations, have strong records of community involvement, respect for human rights around the world, and create safe and useful products.

Today, ethical considerations and alignment with values motivate many ESG investors. According to a 2019 BNP Paribas survey, the portion of both retail and institutional investors that apply environmental, social, and governance principles to at least a quarter of their portfolios jumped from 48% in 2017 to 75% in 2019.

Strong Investment Returns, and Social Gains

In the end, ESG investors want the same thing as any investor – competitive financial returns – while driving positive ESG outcomes. While you might presume that investing for anything other than shareholder value results in lower returns, consistent evidence shows companies that prioritize ESG issues realize superior long-term financial performance. This is true across a range of financial metrics including sales growth, return on equity, return on invested capital, and even alpha (market outperformance). In addition, research suggests a positive correlation between companies that do good and companies that do well financially – and by extension, do well for shareholders.

The investment objective of MCF’s portfolio is to preserve and improve purchasing power of principal, deliver an income stream consistent with a 4.25% payout, and produce consistent returns. The portfolio, which holds only publicly traded stocks and bonds, had a net return of 11.04% for second quarter 2020 and a year-to-date return of -3.10%. The December 31, 2019, the portfolio’s return was 22.87%, beating its benchmark of 22.18%.

Put simply, an ESG portfolio is a portfolio with a purpose. Donors can use their investments to have a positive impact on people and the planet and via MCF’s ESG portfolio, right here, in our local community.