Portfolio building
Purpose and positive impact are two elements Miller looks for in every company he considers for the portfolio. “We’re looking for companies that are having a positive impact on the communities they operate in, the employees in their workforce, and the consumers to whom they offer a great value proposition. And ultimately, we attach this to a goal of generating a strong financial return to this purpose-driven approach.”
Rather than selecting stocks for the portfolio that just happen to fall within the realm of acceptability by ESG standards, the Fund takes a close look at each prospective holding on a case-by-case basis. “We're really looking for the top companies that are doing a good job of addressing their material ESG issues across their business. We're analyzing the specific issues, and we're engaging with the companies to make sure we fully understand the issues that are arising.”
Miller doesn’t try to focus on companies within just one discipline of ESG but takes what he calls “a holistic approach.” “We do not use any sector exclusions. But rather we put every company through the same investment process. This allows us to identify opportunities in the market place rather than avoiding specific sectors based on ambiguous exclusion criteria.”
Miller evaluates what companies are doing across the entire environmental, social, and governance spectrum. “We're looking for companies that can successfully serve the individual needs of their end stakeholders, while leaving some flexibility in our process to account for certain challenges and issues that these companies are currently working through to try to solve.”
He added: “The fund does not utilize any type of political, social or moral guidelines to select ESG investments. But rather the fund is focused on identifying financially material ESG topics to improve the risk adjusted return profile of its investments.”
Miller believes that, as an actively managed portfolio, the Fund team has an advantage over passive ESG funds because of their opportunity to analyze companies from a complete 360-degree perspective. “We are able to engage with each company and talk through what they're doing, what they're seeing, and how they’re managing their business, because ultimately, they have a perspective that is important to consider. We believe that our ability to understand what's really happening on the ground gives us an advantage over the typical passively managed ESG index fund with 300 to 500 individual securities.”
Assessing ESG strengths
Sifting out promising ESG stocks takes a little extra effort, first to make sure the company is appropriately addressing ESG issues, second, to ascertain that the company has a viable business plan with solid prospects for growth, and third, that both of those pieces fit neatly together.
In his analysis, Miller breaks down each company’s ability to address what he considers to be the six primary stakeholders—the environment, employees, customers, suppliers, community, and corporate governance policies and procedures.
“This helps us identify potential opportunities in a business model and the specific points of differentiation,” explains Miller. “If our research indicates the company is doing a particularly strong job in any one or, ideally, several of these categories, this helps us formulate a picture of what their competitive advantage really is going forward.”
Once the Fund’s analysis is complete, adds Miller, “we're left with a better understanding of the company's risks and opportunities through their business ecosystem, which helps us make a better investment decision—while also engaging with those companies on the issues that we think are financially material from an ESG perspective.”
For instance, in the environmental area, Miller and his team assess each stock by paying particular attention to how the company is impacting the natural world around them—and what strategies it has to reduce that impact over time.
“We're looking for companies that can create emissions as efficiently as possible in the short-to-medium term and then ultimately reduce those over the long term,” Miller noted. “We're looking for companies that have a strategy to solve water scarcity challenges, consider biodiversity impacts, and then also invest in circular business models that create great efficiencies for the environment, as well as the individual companies.”
One example, Miller and team assessed a company in the health care industry in three key areas—improving outcomes, increasing coverage for underserved individuals, and maintaining strong data security and privacy standards. “If we believed they were improving outcomes and increasing coverage to underserved individuals who otherwise would have gone untreated, we could flow that through directly into our revenue forecast and into our profitability forecast to attach that to our estimate of long-term upside.
“But if we go through all of this,” adds Miller, “and determine that they're doing all these great things, but that’s already priced into the financial model, then we don't own that company in the Fund.”
Miller also believes it’s important that companies that are pursuing ESG initiatives are doing it for the right reasons. “We’re focused on those companies that are doing their best in human capital standards or setting aggressive environmental targets. And they're doing this because it feeds into the core vision of what they believe is the future path of that company, not because it's something that is subtracting from their end investment results or operating productivity as a company. Increasingly, we are seeing a growing body of evidence that those companies who do address these topics head-on, try to operate in a sustainable manner, invest in their employees, and tackle these material ESG issues may also see an improvement in their potential performance.”
‘Unpacking social’
The Fund team addresses social topics related to ESG by utilizing a concept that Miller calls “unpacking social.” In the process, they break down their analysis into four social areas of ESG – employees, customers, suppliers, and the communities in which the company does business.
“That allows us to dive into the specific topics companies need to address to successfully serve these individual stakeholders, as opposed to just looking at it as one overarching bucket or looking at one element and trying to move on,” said Miller. “We can dive in with more granular detail and understand the individual elements that we need to assess to make an effective determination on these topics.”
Working with SASB
The Fund management team evaluates prospective holdings using criteria provided by the third-party ESG materiality framework from the Sustainability Accounting Standards Board (SASB). SASB has worked with stakeholders in various industries to help identify the most financially material ESG issues by industry.
SASB identifies several key areas of interest by industry, explains Miller, “next SASB indicates where they believe these concerns could show up in a company's financial statements – if they've properly addressed a particular category or if they’ve faltered in that category. We can tie this directly into our fundamental analysis of the company, and feed that into our financial model, and ultimately our assessment of the long-term valuation for the company.”
Within the governance category, the Fund focuses on accountability and alignment. “We're looking for an independent board; we're looking for effective disclosures,” noted Miller. “We're looking for ethical conduct, and we're looking for increased disclosures to help provide the information we want to see in making our investment decision.”
From an alignment perspective, the Fund analyzes areas such as pay practices, long-term investment decisions, and capital allocation. “We know the investments that these companies are making today ultimately become our returns in three to four years,” said Miller. “So, we really want to see companies that have a robust process around capital allocation and a right to win in the areas where they're making investments.”
Sustainability
ESG factors play an important role in investment management to help identify risks and opportunities.
“From an opportunities perspective, we believe it is helpful to understand what companies are doing to position themselves as a part of the solution to various challenges,” explained Miller. “For example, the world is going through an energy transition driven by regulation, national security, and improved efficiency of more recent energy generation sources. Our ability to identify companies that can play a role in this transition and help other companies achieve required targets give us the ability to identify potential opportunities for investment.”
Can focusing on ESG stocks actually improve portfolio performance? While evidence is inconclusive given the brief period that ESG investing has been popular, Miller suggests that incorporating ESG factors in building a portfolio may contribute to strong investment performance for a couple of reasons.
“We know ESG topics are receiving significant attention from executives and board of directors in shaping company strategies for the coming years,” said Miller. “Based on this focus and implication on company strategy and investment, we believe having a system to engage and analyze the decisions companies are making today will be crucial to identifying opportunities over the coming years.”
He also points to a growing body of academic evidence to indicate that ESG topics may have an impact on stock performance (see table below).
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