Incorporating Active ESG Share in Client Portfolios

On July 12, 2023, University of Notre Dame Assistant Professor Rafael Zambrana, Tran Capital Management’s Quoc Tran and London-based Foresight Group’s Nick Scullion discussed the concept of Active Share in ESG Investing. The following are highlights from the call.

  • The concept of Active ESG Share was developed due to the tremendous amount of assets in ESG products; there was no consensus between ESG information and stock returns.
  • Active ESG Share quantifies how different a Fund’s full distribution of the stock-level ESG rating is from its benchmark.
  • The research measured whether active fund managers incorporate ESG information into their portfolio construction and how those decisions impacted fund performance.
  • Tran Capital incorporates ESG analysis, scoring companies on a 1-5 scale and compares it with third-party data to try to reduce risk and provide long term growth.
  • Holdings that exemplify companies other ESG strategies may not hold include Aptiv, a key supplier in the automotive industry, providing electronics and safety technology to global automakers and Ball Corp., which manufactures recyclable aluminum cans, contributing to environmental improvement relative to plastic bottles and containers.
  • Foresight Group is a high-conviction active manager, focused on sustainable infrastructure companies with high-quality earnings streams and in sectors with secular growth.
  • The Fund invests in companies that generate revenue from physical infrastructure assets, focusing on sustainable sectors including core and energy infrastructure, renewable energy generation, buildings and transportation, and social assets that deliver critical services to society.
  • To avoid a fund that is “greenwashing,” it is critical to identify its true benchmark but consider activist investors who seek to improve firm practice.
  • The research revealed that ESG funds outperformed with Active ESG Share, while directional ESG strategies lead to lower performance. ESG investing requires expertise and should not rely solely on public ratings.
  • Quoc Tran believes an ESG filter combined with deeper analysis can reduce risk while investing in companies with secular growth themes.
  • Nick Scullion believes performance and sustainability are linked; companies that thrive in a decarbonized world will be the most successful companies in the long term.
  • While an investor might be willing to pay a higher price and accept a lower return for a “safer” investment, Active ESG Share provides a better risk/return measure when building a portfolio that hedges against those future risks.
  • ESG information is valuable but complex. Prioritize Portfolio Managers that conduct thorough ESG research rather than those who rely solely on public ratings; an ESG portfolio may mitigate risk relative to other non-ESG portfolios.
  • What’s Next? An intriguing area of future research is to apply the ESG active management measure to all asset classes including fixed income.
  • Nick Scullion was surprised at the speed at which equity markets shrugged off some of the persistent risks within the global economy.
  • Quoc Tran believes over the rest of 2023 market returns should come from a broader range of U.S. stocks and inflation should continue to decline. Low levels of investor optimism could indicate a positive market going forward.