So much, so fast
The field of sustainable investing has expanded quickly in scale and scope, with total U.S. sustainable fund assets more than doubling during the three years ending in June 2022.1 In addition, ESG-related media headlines soared by about 50% in 2021.2 This rapid development has created opportunities, and also some challenges.
Any practitioner of sustainable investing is accustomed to operating in an environment that is simultaneously “too much” and “not enough” – including constant assertions that the field is both overly ambitious and woefully deficient. This dynamic is not unique to sustainable investing. For example, at times of peak market exuberance, valuation-focused investors frequently feel that they are taking on too much absolute risk, and yet not enough to keep up with high-flying averages. These in-between places and times are not always pleasant, but they are full of opportunity.
"We aim to demonstrate that the best opportunities lie not at the extremes of ESG rhetoric, but at the heart of sustainability substance.”However, the extremes of the too much/not enough sentiments around ESG have broadened considerably in recent months, and the rhetoric is increasingly dramatic and imprecise, with potentially serious business consequences. Back-to-back news stories in the field report on topics like the Texas Comptroller’s list of alleged oil boycotters (“too much”) and the dissolution of partnerships between intergovernmental organizations, nonprofit affiliates, and asset managers (“not enough”). Again, this kind of polarization is not unique to ESG – we can see it across a wide range of settings, issues, and geographies.
Explaining the current state of affairsThere are logical reasons for amped-up sentiment. First, practitioners of sustainable investing employ a wide variety of approaches, making the scope of activity under the giant umbrella of ESG inherently wide.
Additionally, as noted above, a wave of increased activity from investors, corporations, activists, policymakers, media, and regulators has produced a flood of products, content, and commentary. All of this has coincided with a series of interconnected crises (pandemic, social justice, climate, and economy), and escalating socio-political division. These ingredients are each individually complicated, and they also have combined in an especially powerful way.
The result is not so surprising. ESG, had once represented a specific and wonky analytical framework for considering connections between environmental, social, and governance issues and long-term financial performance. Now it has become a catch-all label for some of the most complex and high-consequence issues of our time, amplifying both emotions and extremes.
Specific considerations within the investment communityAlong with the general conditions noted above, there are within the investment community some specific areas of ESG-related complication. Many of these relate to the desire to streamline and standardize ESG-related activity — an understandable goal, but one that needs to be carefully focused. For example, while standardization of primary data quality and industry terminology is likely helpful, standardization of global policy directives or analytical approaches might be misguided.
Varied regional settings The policy backdrop for the United States is different than Europe. U.S. securities regulators are focused on clarity of ESG disclosures, while policy decisions like the Inflation Reduction Act aim at accelerating climate-related solutions like clean energy and community investment. Rather than expecting a single EU-style approach to global policy, we might recognize that political, social, and economic contexts differ widely across different regions of the world. For this reason, varied approaches to policy might therefore be not only warranted, but preferred.
Varied asset management approaches Similarly, ESG-related practices for active managers can – and likely should – differ from passive managers. For an active manager like Putnam, where our goal is to assess individual issuers and securities, a focus on materiality that is tailored by asset class, sector, and company is more relevant than a top-down system of standardized scoring or exclusionary lists.
Varied ESG functions Additionally, we recognize a wide range of activity now shares the “ESG” label. For instance, across different asset management settings, ESG activity can be focused on risk mitigation, alpha generation, values expression, or compliance monitoring. These are often dramatically different functions: Many settings would benefit from clarifying the purpose of specific ESG endeavors, instead of leaping straight to implementation.
Most important, ESG metrics do not reflect the awesomeness of the actual world. Partly due to the elements noted above, our profession has sometimes been willing to use sweeping forms of shorthand with respect to ESG metrics and their use, as if they are (1) universally relevant, (2) consistent, accurate, and comparable, (3) able to be normalized and reduced without losing information value, and (4) directly linked to outcomes and impact. This is unwise and again is not unique to ESG analysis: just look at revenue recognition, or stock-based compensation, or pension accounting. Though many financial tools are more established than ESG metrics, all of the tools of finance are imperfect for representing the dynamic, evolving businesses that exist in our world. One of the joys of being an active manager is knowing that thoughtful analysis can assemble a more complete picture than any one metric in isolation or abstraction.
Characteristics of Putnam’s active management approachSometimes when the noise level rises to extremes, the true signal shines through even more clearly.
Despite the challenges noted above, the strategic relevance of ESG issues in our world continues to rise. This means that for an active manager like Putnam, opportunities for alpha creation and risk mitigation are also rising, supported by the following design principles:
- Proactive focus: As active managers, we have a great opportunity to focus not on exclusions, but rather on the essential question, “What are we FOR?” This inclusionary approach aims to identify ESG and sustainability-related strategies, performance, and solutions that can result in improved long-term financial performance.
- Investment-centric approach: The potential for fundamental investors to consider sustainability issues in a thoughtful and investment-centric way remains compelling. When a tough question arises, our team’s goal is to meet it with open-minded curiosity and research. We are willing to do the harder work to get to better answers (or better questions), with the goal of enhancing long-term investment performance.
- Context-specific analysis: Our investment research is context specific and forward looking, and we view these ingredients as essential to any approach focused on investment merit. Within equities, for example, we are more interested in analyzing corporate sustainability strategy than in ESG compliance reports or opaque third-party scoring systems. Across asset classes, our ESG integration frameworks focus on materiality.
We aim to demonstrate that the best opportunities lie not at the extremes of ESG rhetoric, but at the heart of sustainability substance.
1 Morningstar report, “Global Sustainable Fund Flows: Q2 2022 in Review.”
2 Cognito media report, “The Communications of Climate Transition,” June 2022.
As part of our investment analysis, depending on the strategy or portfolio in question, we may integrate environmental, social, or governance (“ESG”) issues or considerations into our research and/or investment decision-making. In our view, analysis of ESG issues is part of good investing, as these issues, like other, more traditional areas of investment analysis, such as market position, growth prospects, and business strategy, have the potential to impact risk and returns. For example, in the governance area, evaluation of the strength of a company's management has always been a critical consideration in our investment process. The relevance and materiality of other ESG issues in our process will differ from strategy to strategy, from sector to sector, and from portfolio manager to portfolio manager, and for some strategies, most notably those where we lack relevant ESG data, ESG considerations are not a material part of our process. It is also important to note that consideration of ESG issues does not mean that a particular account pursues a specific “ESG” or “sustainable” investment strategy, and, depending on the strategy, we sometimes make investment decisions notwithstanding the associated ESG considerations. In all cases, our task is to pursue the agreed-on investment objective for a given account. In our view, pursuing that goal often requires appropriate consideration of ESG matters, just as it does other investment factors.
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