Environment, Social, and Governance
The investment industry’s gold standard on assessing ESG is generally based on analyzing a company’s historical actions and public disclosures. This information—usually sourced from a third party provider—is aggregated and used to screen the universe’s strongest and poorest performers. Relying on backwards-looking, inclusionary/exclusionary ESG ratings can lead to large divergences between what the market perceives to be “good” or “bad” ESG performance versus reality. We believe that these types of screening methods do not capture the full alpha-extracting potential based on ESG factors.
- Investors tend to avoid companies whose current ESG metrics are weak relative to those of its peers. However, businesses that score poorly today may be implementing initiatives to improve their ESG profiles over time. Future performance is generally not captured in third-party ESG scores. This is why we assess and establish an ESG forward rating.
- Many companies simply lack adequate disclosure of otherwise strong ESG strategies and programs already in place. These hidden gems are generally unknown or underappreciated by the broader market, often leading to large perception-reality deltas. In these situations, we engage with management to better understand the risk profile of their business and approach to ESG.
We have developed a propriety analysis framework that analyzes businesses on 3 – 5 most material ESG risks and opportunities. For example, some of the ESG issues we consider are as follows:
- Carbon Emissions
- Raw Material Sourcing
- Water Scarcity
- Packaging Lifecycle
- Sustainable Building
- Labor Practices
- Health & Safety
- Data Security
- Racial & Gender Equality
- Community Stewardship
- Board Practices
- Executive Compensation
- Minority Shareholder Protection
- Auditing Frameworks
We believe in engaging companies directly on ESG matters. These dialogues not only improve our informational edge over the market but also serve as excellent forums for collaborating with management on identifying new areas of ESG risk and opportunity.
Many of our conversations are aimed at raising awareness of material ESG issues that may not have been considered by management. In other cases, we bring to bear our expertise in ESG to encourage strategic changes to improve competitive positioning and the idiosyncratic risk profile of the business.
We also work with companies to recommend improvements to ESG disclosure, as some may be tackling major structural challenges but not effectively communicating their efforts to the market.
Taking a proactive approach to voting our proxies is an important part of our engagement framework. Through this mechanism, we can encourage improved corporate governance practices and align portfolio companies with our views on environmental and social challenges. We believe businesses that effectively address ESG issues, whether by mitigating risk or seizing opportunity, are best positioned to create long-term shareholder value. As such, we expect to vote in line with our ESG framework, specifically:
- Environment – Examine companies’ environmental risk/opportunity exposures on a case-by-case basis and take into consideration material environmental factors, such as sustainable sourcing, climate change, energy management, and water stress.
- Social – Examine companies’ social risk/opportunity exposures on a case-by-case basis and take into consideration material social factors, such as racial and gender equality, human rights across the supply chain, product safety mechanisms, and data security.
- Governance – Examine companies’ governance risk/opportunity exposures on a case-by-case basis and take into consideration material governance factors, such as board independence, compensation, transparency, and minority shareholder protection.
In July 2018, Blackcrane Capital became a signatory to the United Nations Principles of Responsible Investing (UN PRI), which serves both as a consortium of ESG-minded investors and a developer of voluntary, aspirational investment principles. We are also a supporter of the Task Force on Climate-related Financial Disclosures (TCFD).