Sustainable companies are those which score highly on environmental, social and governance (ESG) factors in their business operations. The degree to which a company is sustainable can be a crucial factor in deciding whether its stocks and bonds should be included in an investment portfolio. Robeco routinely screens all companies under consideration for inclusion in portfolios as standard practice, using different ESG thresholds depending on the type of fund or strategy.
Screening mostly takes two forms – negative and positive – backed by research and access to reliable data. Negative screening essentially means excluding those companies that do not meet pre-determined ESG standards and typically includes makers of controversial weapons, companies engaged in human rights abuses, or corporate governance failures such as corruption. Robeco also excludes all tobacco companies and those engaged in the extensive production or use of thermal coal, subject to certain thresholds.
Positive screening means examining the ESG credentials of the companies that remain in the investment universe after the exclusions have been carried out. Different companies will get varying scores according to their business, and the E, S and G will have differing levels of importance according to the sector. For example, a mining company may score poorly on environmental management and social factors, but be superbly managed and score highly for governance. Conversely, banks may score highly for environmental and social factors, but poorly for governance due to their excessive risk-taking during the financial crisis.
Some industries may also face contradictions in their ESG profiles. Electric car makers, for example, are seen as the solution to removing reliance on fossil-fuel powered internal combustion engines, and would naturally be considered as ‘sustainable companies’. However, some raw materials needed for car batteries such as cobalt or rare earth minerals are often produced in regions with poor labor practices and environmental records. A complete picture must therefore be established to ascertain a company’s true ESG credentials and whether it should be labeled as sustainable.
As not all ESG factors are equally relevant, it is also important to only consider the most financially material factors – ESG issues that directly affect the company’s financial performance. This is a vital component in ESG integration in the decision-making process for investment strategies, as screening needs to focus on metrics that would ultimately affect the company’s ability to create value, and therefore its future share price. Ultimately, companies and investment strategies are judged on their financial performance, not the headlines they may make. Robeco has long believed that more sustainable companies create more value over time, as ESG allows for a better lens to assess business risks as well as opportunities.