Active engagement: how top ESG managers make a difference

Environmental, social, and governance (ESG) investing has evolved.

Just a decade ago, ESG investing—also known as sustainable and responsible investing—was largely confined to excluding investments in companies that produce goods and services perceived as harmful to society, such as weapons, cigarettes, alcohol, and gambling. Today's top ESG portfolio managers are proactive, directly engaging with firms and investing in those making the most significant positive impact in a way that potentially enhances long-term financial strength.

John Hancock Investment Management recently gathered three portfolio managers for a roundtable discussion on today's highly engaged approaches to ESG investing. These specialists focus on different asset classes—U.S. equities, international equities, and fixed income—and each is from a leading ESG asset manager with rich heritage in the field.

While each portfolio manager brings a unique approach to combining financial returns with positive impact, they share a common commitment: exerting influence so that the best companies can become even better, in terms of sustainability as well as the potential to generate strong investment returns.

“We're performing deep fundamental analysis to seek to find the best companies and challenging those companies to do better,” says Cheryl I. Smith, Ph.D., CFA, a U.S. equity portfolio manager with Trillium Asset Management.

As the longest-standing ESG-only asset manager in the United States, Trillium, founded in 1982, believes it has a responsibility to actively engage portfolio companies. Passive approaches that seek to track equity indexes of companies meeting certain ESG criteria don't enable true engagement, Ms. Smith says. “We really pay a lot of attention to ESG integration to see how companies manage risk. That isn't something that you can achieve with a simple check-the-box, passive approach that merely excludes companies that aren't in an ESG index.”

Trillium's portfolio managers are supported by a team of specialists that works with management at companies with strong investment profiles to address any potential shortcomings in their sustainability practices. For example, Trillium engaged with an information technology company to secure a commitment to reduce nonrenewable energy use at its data centers—a commitment that could ultimately help the firm reduce its overall expenses and potentially improve its bottom line. At an industrial company, Trillium backed a shareholder resolution that led to the establishment of policies protecting gay, lesbian, bisexual, and transgender employees from workplace discrimination. Such policies help ensure that a company can draw from the largest possible pool of talent to build and retain a strong base of employees, Ms. Smith says.

At Boston Common Asset Management, a manager of domestic, international, and global equity ESG strategies, the emphasis is on constructive dialogue on ESG issues; the firm's corporate engagement specialist makes overseas trips to meet with management teams. In Japan and other Asian countries, Boston Common discusses the importance of reforming corporate boards to ensure that independent directors are sufficiently empowered. Boston Common also engages with firms to address gender inequity in the ranks of directors and management. Japan's population is simultaneously shrinking and aging, and women must be afforded greater economic opportunities to ensure the long-term diversity and viability of the nation's workforce, says Matt A. Zalosh, CFA, a Boston Common portfolio manager and the firm's CIO of international strategies. “We think that there's more to come in Japan,” he says.

In fixed income, the incorporation of ESG criteria into traditional credit analysis provides a more complete picture of a company's credit profile, according to Khurram Gillani, a fixed-income portfolio manager with Breckinridge Capital Advisors. The firm seeks to identify borrowers employing practices focused on long-term viability through reduced costs, less waste, and greater efficiencies—attributes that can enhance not only a borrower's financial strength but its capacity to positively affect sustainability.

The portfolio management team is backed by analysts who comb through borrowers' regulatory disclosures for details about business practices and sustainability factors. The emphasis is on reading, listening, and learning as much as possible about each borrower to scrutinize financial strength and sustainability factors, then focusing investments on the borrowers having the most positive impact. “We want to find the best actors in every industry,” Mr. Gillani says.

Incorporating ESG issues into credit analysis provides a holistic view of the factors that can affect the present and future value of a bond, Mr. Gillani says. For example, does an industrial company's financial outlook fully factor in the prospect of increased raw material costs or higher water supply expenses in a world of finite resources? If a public controversy suddenly puts a company's labor practices in a negative light, is the firm's management and culture sufficiently strong that it can respond appropriately and quickly take corrective action if necessary? Incorporating ESG criteria “is really a way to get to know our borrowers better,” he says.

As an international equity portfolio manager, Mr. Zalosh can be unusually selective, owing to the wide range of non-U.S. opportunities to invest in companies around the globe with attractive investment characteristics and strong ESG profiles. In many instances, international companies are ahead of their U.S. counterparts when it comes to integrating sustainability factors into their businesses. “We see ESG practices in places such as Europe that are well ahead of where we are in the United States,” Mr. Zalosh says. Moreover, while many emerging-market companies may trail U.S. firms on financial transparency and other measures, in terms of ESG investing, the emerging markets appear to be making greater progress than U.S. firms on several fronts, Mr. Zalosh says.

Within U.S. equities, however, Ms. Smith sees no shortage of opportunities to invest in financially strong companies bringing about positive change. Since joining Trillium in 1987, she's seen rapid growth in the number of top firms with enduring commitments to ESG principles—a development she welcomes, as it's afforded her a larger universe of ESG-eligible companies to consider as potential portfolio holdings.

“We've really seen an acceptance of ESG principles by most companies,” Ms. Smith says. “They really recognize it as a positive for their businesses.”