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Socially Conscious Due Diligence

by Kemp H. Hanley

Socially conscious investing has captured increased buzz recently. Generally, it involves investing in companies that are committed to environmental, social, and governance (ESG) causes, or else avoiding companies that engage in “sin” industries. As can be expected, iShares, Vanguard and others have developed funds that target the socially responsible investor. According to the United States Forum for Sustainable and Responsible Investments, ESG currently captures $1 for every $6 under professional management in the United States. According University of Oxford researchers:

► 90% of 200 studies considered confirm that sound sustainability standards lower a company’s cost of capital
► 88% of the research shows that solid ESG practices result in better operational performance of firms
► 80% of the studies show that stock price performance of companies is positively influenced by good sustainability practices


What is ESG?

ESG refers to the three pillars used to measure the sustainability and ethical impact of an investment in a business. Investopedia breaks it down as follows:

► Environmental criteria looks at how a company performs as a steward of the natural environment

► Social criteria examines how a company manages relationships with its employees, suppliers, customers and the communities where it operates

► Governance criteria deals with a company's leadership, executive pay, audits, internal controls and shareholder rights.


How does this affect due diligence?

 Internally at FactRight, we have a constant dialogue on company culture and how it fits into our sponsor/operational due diligence process. We know it when we have completed an onsite with an organization that exhibits a positive culture. Sometimes a company is proud to highlight for us their commitment to employee health or community service. Other times we see it displayed in the company offices or reflected in governance documents. And on occasion, it is apparent that the organization has not given ESG-related areas a lot of focus.        

 In my mind, organizations who have an eye toward developing and fine-tuning an effective ESG program are forward thinking, which in turn reflects on the company’s culture. A defined approach makes business sense and social and governance policies have a material effect on the business in the long run. I am not alone in thinking that good social and governance policies will tend to translate into better investor returns overall.

 The difficulty from a due diligence perspective is that there is no consensus on what constitutes good or bad ESG strategies. The governance side is a bit more straight forward. Insights into general corporate governance policies and practices such as executive compensation, shareholder rights, diversity and equal opportunity, and worker rights can be gleaned from documents requested and interviews with HR and employees. However, environmental and social aspects are bit more subjective. As a start, I would ask if the company has an annual corporate responsibility report that documents performance and establishes goals to drive short- and long-term strategies. If the company has not articulated a strategy, and many smaller organization have not, ask management about philanthropy or if any resources are devoted to the communities they do business in. Ask about how the company approaches employee health and wellness or whether or not it has developed any ecofriendly policies, like reducing energy and water use, lowering carbon footprints or improving waste management. These lines of inquiry will get the conversation started.