ESG: A Signpost for Identifying Opportunities and Risks

Nick Niziolek, CFA and Paul Ryndak, CFA

In recent years, environmental, social and governance (ESG) factors have become increasingly important to many governments and companies, as well as investors. Because they are allocators of capital, their priorities have broad investment implications.  For example, as governments prioritize environmentally related goals—through budgets or regulation--environmentally friendly products and services will benefit. Meanwhile, business that rank low in ESG factors will increasingly be shunned by a growing pool of investors.

The Calamos global team first began formally integrating ESG into our process for the Calamos Evolving World Growth Fund (CNWIX) in January of 2017. By early 2018, we had integrated ESG research into all of our global equity strategies. In August 2018, Calamos became a signatory of the UN Principles for Responsible Investment, expressing our commitment to responsible investment and participation in a global community seeking to build a more sustainable financial system.

ESG: An additional lens for our fundamentally driven process

First and foremost, our approach to ESG reflects our commitment to serving the best interests of our clients. As we state in our ESG charter, “Our commitment to investing revolves around our fiduciary responsibility to our investment advisory clients, and our dedication to generating the best risk-adjusted returns possible in line with our clients’ investment objectives.” Our primary focus is on identifying investments we believe will outperform over time, using a fundamentally driven investment process that considers many types of factors, including ESG.

Incorporating ESG scores into our process has not required any major shifts in our approach. Our fundamental analysis already included many of the same considerations highlighted in ESG ratings. For example, our bottom-up investment process includes rigorous scrutiny of management and corporate governance, as both can have a significant bearing on downside risk.

In addition to our internal research, we utilize a third-party ESG rating provider for ESG scores and commentary. We include this information as a standard part of our company reviews, and we continually monitor our portfolios for any changes in ESG ratings.

One common misconception about ESG investing is that it focuses only on finding the highest-rated ESG companies, such as those in “green industries” like solar power or electric vehicle batteries. ESG investing principles are multi-faceted and can provide insights into companies across sectors.

We believe there are two primary ways to incorporate ESG into our research:

1. We use ESG analysis to identify company risks. These risks include, among others, governance concerns, audit issues, labor conflict, and environmental risks that could lead to further regulation and/or weaker demand for products and services. Many companies will face future cost burdens as they address these issues. In a world where ESG is becoming a higher priority for investors, avoiding companies exposed to these risks can help us avoid underperforming equities.
2. We use ESG research to identify opportunities. Globally, governments have been adjusting their budgets to reflect the priorities of voters, who are increasingly putting environmental and social issues at the forefront. There are many businesses that can benefit from growing demand for environmentally friendly products and services. These include companies providing solutions to the climate challenges faced by governments and businesses around the world.

We expect ESG will gain momentum in coming years, although the extent to which it does will vary by country. In addition to more investor interest, we believe we’ll see more stringent emissions standards in most countries, including emerging markets. Governments will push for more renewable energy, environmentally friendly buildings and more sustainable transportation to lower CO2 emissions. More consumers will choose electric or hybrid vehicles instead of those powered by internal combustion engines.

For example, in May, the European Commission announced a €750 billion package to fight climate change, under the heading of “green stimulus.” The plan has grants and loans earmarked for building renovations such as solar panels, insulation and renewable heating systems. Funds from this plan are also targeted toward clean vehicles, clean public transportation, and other renewable energy projects.

We’ve also seen more green bond issuance in Europe. Green bonds allow companies to raise capital at attractive finance rates to fund projects aimed at sustainability.

Conclusion

Guided by our fiduciary commitment, we are committed to seeking out new information and ways to manage risk. While our fundamental process has always encompassed the impact of environmental, social, and governance issues on potential investments, ESG ratings provide another tool in our toolbox for managing our portfolios.