During the last quarter of 2018 we saw news that rattled responsible investors, from the Facebook data breach, Johnson & Johnson’s talc being linked to cancer and Nissan chairman Carlos Ghosn’s arrest for corporate governance related issues.
With more investors moving towards responsible investing, issues like this take on more significance. The Edelman Trust Barometer released last month notes that 91% of institutional investors in Canada have changed their voting and/or engagement policies to be more attentive to ESG risks and 65% have done so within the past year.
Some believe that choosing responsible investing means foregoing some returns. However, Morningstar research finds that this is simply not true.
“Sustainable/responsible funds and indexes perform on par with comparable conventional funds and indexes, despite theory suggesting otherwise,” finds Morningstar head of sustainability research Jon Hale in a paper titled “Sustainable Investing Research Suggests No Performance Penalty”. He notes that companies with higher environmental, social, and governance scores and ratings can outperform comparable firms in both accounting terms and stock market terms.
This is an idea that mutual funds have embraced.
“ESG is a part of our mandate not just for specific ESG focused funds, but across our imaxx mutual funds platform, and we believe that, not only do investors not have to choose between “doing the right thing” and investment returns, but that long term investment results may be enhanced by the improved quality associated with incorporating the principles of sustainable and responsible investing”, says Suzann Pennington, chief investment officer of Foresters Asset Management.
Foresters manages the medalist imaxx Canadian Dividend Plus F0 and imaxx Equity Growth F, among others.
To implement responsible investing, Foresters uses a third party – Sustainalytics – to do the first round of screening. The fund eliminates companies with significant exposures to products like tobacco, pornography, weapons and gambling. However, these are more guidelines, rather than blanket rules.
“With Alimentation Couche Tard, we saw that the company’s tobacco exposure dropped after certain acquisitions. We were hopeful they would reduce exposure to tobacco further and focus on other business lines. On deeper analysis we determined that reducing tobacco exposure was not part of their strategy and in fact the company had a private label brand of cigarettes. So we chose to eliminate that company from our portfolio,” Pennington says.
The portfolio management firm often invests in sectors not usually found in ESG portfolios, like natural resources.
“We rank companies relative to peers in their same field, emphasizing those issues that are most relevant. We rank companies in natural resources based on their handling of climate change issues, engagement with and hiring from local communities, adherence to clean energy, etc. Financial services companies, on the other hand, are ranked based on corporate governance, how they treat their customers, their whistleblower policies, and other issues,” Pennington points out.
Foresters dropped financial services firm Wells Fargo (WFC) because of issues surrounding ethics related to customer accounts, their whistle blower policy, and employee related issues. It also dropped Citigroup Inc (C).
“Citigroup’s pattern of ‘lapses in business ethics’ raised a red flag. In addition to fines and a guilty plea related to forex manipulation the bank has been the subject of several anti-money laundering investigations”, Pennington says.
So which companies make sense for you to invest in?
Three stock picks for this year
Pennington likes three companies for their commitment to sustainability and ESG principles – Agnico Eagle Mines (AEM), Pinnacle Renewable Energy (PL) and Killam Apartment Real Estate Investment Trust (KMP.UN).
“While a mining company is a controversial choice, we believe that gold is an important diversifier for our clients’ portfolios in times of uncertainty and Agnico Eagle has made a concerted effort to be a sustainability leader in its field”, Pennington says.
She points out that the company has a board-level committee for sustainability performance, and a compensation system tied to safety performance targets. It has adopted the International Cyanide Management code and therefore is subject to external audits.
“Agnico has impressively reduced its energy footprint through investment in renewables; is actively engaged with local communities including indigenous rights including hiring and training of members of local communities and efforts to ensure consistent improvements in diversity at more senior levels, and receives high scores for preparedness”, she says.
Morningstar equity analyst Kristoffer Inton estimates the three-star stock to have a fair value estimate of $60, a discount to its current price of around $53. “Given our inclusion of impairments in calculating return on invested capital, we think Agnico’s large asset base weighs on its ability to outearn its cost of capital,” Inton says.
Richmond based Pinnacle Renewable Energy manufactures and distributes industrial wood pellets from biomass waste generated by the timber manufacturing industry.
“Pinnacle maintains very high safety standards, supports local communities’ fire management and has been sought out by industry as a partner for their high operating, transportation and safety efficiencies. Many of Pinnacle’s contracts depend on continuing commitment to environmental standards”, Pennington says.
Her final pick is Killam Apartment REIT. She points out that the mutual fund did not score as highly on traditional ESG metrics, primarily because of a lack of clearly communicated policies.
“Killam is an example of the positive impact engagement can have and has been an excellent partner. It’s great to see a company that really ‘walks the walk’ with its holistic support for community, from a commitment to environmental responsibility (dedicated environmental efficiency specialist, specific targets ensure continuous tangible water and energy improvements), to support for employees (scholarships, assistance and recognition programs), to supporting communities (tenant assistance, non-profit housing, various hospitals and charities),” Pennington says.
