ESG shopping? Do your homework ESG shopping? Do your homework http://www.federatedinvestors.com/static/images/fed-logo-amp.png http://www.federatedinvestors.com/daf\images\insights\article\pen-pencil-textbooks-small.jpg August 20 2019 August 20 2019

ESG shopping? Do your homework

A scarcity of disclosures is creating an information vacuum for ESG investors who rely only on off-the-shelf ratings.
Published August 20 2019
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Investors seeking to integrate environmental, social and corporate governance (ESG) factors into their investment decision-making process have some homework to do. The reason? There is a scarcity of clear ESG disclosures for small and midcap companies, meaning promising opportunities could be missed if only off-the-shelf ESG ratings and investment screens are used.

Even for large companies, ESG disclosures are consistently inconsistent. Researchers have identified four key failings of commonly used ESG ratings, all of which are amplified when applied to smaller companies:

  • Market-cap bias Companies with more communication resources tend to score better.
  • Disclosure/geographic bias National regulatory disclosure requirements drive scores, and scores reward disclosure (not necessarily performance).
  • Industry bias Ratings do not discern between very different business models in the same industry, with more mature and regulated industries generally scoring higher.
  • Reactivity Ratings are dragged down for an extended period of time following a controversy, despite the high likelihood that the companies responsible have consequently implemented changes that could improve their performance relative to peers.

Why does this matter? Investors may miss out. For example, consider Brunswick Corp., a U.S. marine engine and boat manufacturer and one of the holdings1 in the Federated Hermes SDG Engagement Equity Fund. Despite having a below-average ESG rating, after meeting with management and doing in-depth ESG and fundamental analyses, we believe it is a high-quality company for these reasons: 

  • Brunswick has improved aspects of its corporate governance, including declassifying its board to ensure all directors faced election each year.
  • Its manufacturing facilities are cutting-edge in terms of energy usage, air quality and waste reduction. Indeed, its principal Fond du Lac facility in Wisconsin has been winning sustainability awards since 2014.
  • The company has a strong culture evidenced by very low employee turnover as well as high referral rates and a high proportion of female employees.

Had we not done our homework, we never would have uncovered these positives. Luckily, the company has been open to our engagement on ESG topics and has committed to expanding its sustainability strategy and reporting. As its disclosures improve, its ESG rating should rise as well, even if it continues to lag large-caps.

In sum, we believe investors should not depend on ESG ratings alone, but instead seek strategies that thoughtfully consider credible and meaningful ESG analysis.

1 As of 6/28/2019, Brunswick Corp. shares valued at $568,302 represented 2.0% of Federated Hermes SDG Engagement Equity Fund’s portfolio of $28,906,304.

Tags Equity . International/Global .
DISCLOSURES

Views are as of the date above and are subject to change based on market conditions and other factors. These views should not be construed as a recommendation for any specific security or sector.

International investing involves special risks including currency risk, increased volatility, political risks, and differences in auditing and other financial standards.

Investors should carefully consider the fund’s investment objectives, risks, charges and expenses before investing. To obtain a summary prospectus or prospectus containing this and other information, contact us or visit FederatedInvestors.com. Please carefully read the summary prospectus or the prospectus before investing.

Mid-capitalization companies often have narrower markets and limited managerial and financial resources compared to larger and more established companies.

Small-company stocks may be less liquid and subject to greater price volatility than large-capitalization stocks.

The Federated Hermes SDG Engagement Equity Fund's strategy is to target companies that the adviser or sub-adviser believes will contribute positive societal impact aligned to the UN SDGs. The fund may underperform funds that do not have such a strategy.

The holdings percentages are based on net assets at the close of business on 6/28/19 and may not necessarily reflect adjustments that are routinely made when presenting net assets for formal financial statement purposes. Because this is a managed portfolio, the investment mix will change.

There is no guarantee that any investment approach will be successful.

The UN SDGs are as follows: no poverty; zero hunger; good health and well-being; quality education;  gender equality; clean water and sanitation; affordable and clean energy; decent work and economic growth; industry, innovation and infrastructure; reduced inequalities; sustainable cities and communities; responsible consumption and production; climate action; life below water; life on land; peace, justice and strong institutions; and partnership for the goals.

Federated Global Investment Management Corp. is the advisor of the fund and Hermes Investment Management Limited is the sub advisor.

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