The ESG Edge to Concentrated Equity Investing

There are many ways to apply responsible investing principles to portfolios. But some investing approaches may be more conducive to creating a portfolio with strong environmental, social and governance (ESG) qualities than others. Concentrated equities are a case in point.

More investors around the world today are focused on ESG in their portfolios. For some, that means screening out sectors and companies that don’t align with their values, such as weapons manufacturers, tobacco companies or coal-based utilities that pollute the atmosphere. Thematic portfolios that invest in specific sectors with an ESG angle are another way to invest responsibly. Others may want to ensure that ESG issues are incorporated into research before holdings are purchased.

Concentrated Investing: A Natural Sieve

Before choosing a responsible investing approach, investors often ask: will an ESG focus undermine returns? Instead we prefer to turn the question on its head and to ask whether there is a high-return investing approach that can help foster a portfolio with strong ESG characteristics.

Concentrated investors target a small number of high-conviction positions. Choosing a small group of candidates from a vast universe of opportunities requires a well-defined process. In our view, a disciplined concentrated investing process focused on high-growth companies is like a sieve that sifts out companies with weak ESG profiles by following these four guidelines:

    • Avoid cyclical businesses—Cyclical businesses depend on the economic cycle to outperform and are not well suited to a concentrated growth portfolio, in our view. These typically include companies in heavy industries such as oil and gas. By avoiding cyclical companies, a concentrated growth portfolio will filter out heavy polluters, almost by default. Noncyclical companies include healthcare, life sciences and technology groups, which often perform well on environmental and social issues. Excluding cyclical businesses leads to portfolios with a substantially lower carbon footprint than the broader index.
    • Engage often with management—Engagement is important for any active investor. But concentrated investors can take a highly proactive approach because there are far fewer companies in the portfolio to engage with. Keeping in close contact with company managements is an essential ingredient for effectively promoting positive ESG changes in a company.
    • Beware of regulatory risk—Concentrated investors should stay away from businesses that are subject to significant regulatory risk, in our view. Regulatory action is almost impossible to predict and the risk of a share price imploding over a regulatory issue is too great to bear in a portfolio with so few stocks. By steering clear of heavily regulated industries, a concentrated portfolio will usually rule out problematic holdings such as tobacco, energy and utility companies.