How to Profit From “The Halo Effect”
Environmental, social and governance (ESG) factors are gaining prominence in the strategic decisions of Wall Street and corporations. Not because financial and corporate leaders have suddenly become bleeding hearts, but because ESG is good for the bottom line.
Consider BlackRock (NYSE: BLK), the world’s largest asset manager. With more than $7.4 trillion in assets under management, BlackRock recently launched several new exchange-traded funds (ETFs) that track ESG-focused companies. No one ever accused the top managers at BlackRock of being sentimental do-gooders.
I’ll resume covering the market’s daily actions in my video update on Monday. But today, as issues such as climate change capture headlines, I want to step back to examine ESG and how it’s transforming the investment world. Think of it as “The Halo Effect.”
Doing well, by doing good…
ESG traces its origins to socially responsible investing, which strives to avoid “sin stocks” in such areas as tobacco, alcohol, weapons, and gambling.
But the term “socially responsible” has given way to the more comprehensive ESG, which focuses on proactive practices in a broader range issues.
Companies earn low ESG scores for a variety of factors, such as absentee boards, poor safety records for products and workplaces, abusive office environments, and excessive pollution. The premise is that a low ESG score increases a company’s exposure to costly litigation, fines and high employee turnover. By contrast, top ESG scorers are likely to be innovators and market leaders, with fewer wasteful practices.
According to a study released September 17 by Consultancy.org, an increasing number of pension plans around the world are placing a greater focus on EGS, particularly climate risk.
Equity strategists at Bank of America (NYSE: BAC) recently analyzed thousands of publicly listed companies based on their ESG practices. In their global report ESG from A to Z, they found that companies scoring highly for ESG practices generally performed better in terms of operating results and share prices than those in their sectors that scored poorly.
According to research firm FactSet, corporate managers are jumping aboard the ESG bandwagon. FactSet (the data provider for Investing Daily) reported an increase in S&P 500 companies citing “ESG” on earnings conference calls in the second quarter versus the first quarter of 2020.
In its survey released this month, FactSet searched for the term “ESG” in the conference call transcripts of all the S&P 500 companies that conducted earnings calls from June 15 to September 5.
Among these companies, 60 cited ESG during their calls, a 100% increase compared to the number of companies citing the term in the previous quarter. The following chart breaks down ESG mentions by S&P 500 sector:
The devastating wildfires on the West Coast pose a salient ESG theme, as scientists point to climate change as the cause. The safety scandal that plagues the Boeing (NYSE: BA) 737 MAX aircraft is another example. Woes like these cost many billions of dollars, a fact not lost in C-Suites…or on BlackRock CEO Larry Fink.
In a 2020 letter to clients, Larry Fink wrote:
“The investment risks presented by climate change are set to accelerate a significant reallocation of capital, which will in turn have a profound impact on the pricing of risk and assets around the world.
As your fiduciary, BlackRock is committed to helping you navigate this transition and build more resilient portfolios, including striving for more stable and higher long-term returns. Because sustainable investment options have the potential to offer clients better outcomes, we are making sustainability integral to the way BlackRock manages risk, constructs portfolios, designs products, and engages with companies. We believe that sustainability should be our new standard for investing.”
Fink promised to double BlackRock’s sustainable ETF offerings, encourage index providers to increase their focus on ESG, and drop coal producers from BLK’s investment products.
Wall Street is following BlackRock’s lead on the energy sector. The perception among investors is that coal and other fossil fuels are in the rear view mirror and future growth belongs to green energy.
Oil fueled the 20th century, but the coronavirus pandemic is accelerating the shift to a new energy paradigm. When COVID-19 clobbered the global economy in early 2020, oil demand plunged by more than a fifth and prices imploded. As corporations and governments grapple with climate change, cleaner energy will dominate the 21st century.
ESG meets 5G…
ESG-friendly industries will be heavily reliant on digital innovation, such as the Internet of Things (IoT). Instrumental to IoT is the global roll-out of 5G (“fifth generation”) wireless. Energy-efficient smart homes and factories, renewable energy grids, autonomous electric vehicles…all of these technologies will rely on the ultra-fast speeds of 5G.
If you’re looking to tap into the trends that I’ve just discussed in this article, consider our top pick for the 5G revolution. The 5G rollout will be impossible without this small company’s key technology.
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