Be careful when drawing conclusions about the environmental, social, and governance (ESG) performance of investment portfolios based on ratings services. These services are proliferating for a good reason: investors are seeking guidance on how best to combine investing with social and environmental impact. But sustainability ratings, as they are known, too often suffer from information shortfalls or simplistic scoring methodologies that fail to account fully for a portfolio’s sustainability objectives.
For example, our US Small Cap strategy would have earned a “D” grade on gender equality in the recent launch of As You Sow’s Invest Your Values “Gender Equality Funds” online tool. The grade is based on data provider Equileap’s assessment of greater than 3,500 global companies with respect to gender balance on their boards, senior management, and in the workforce, as well as corporate policies that further gender equality.
This grade would be unsurprising since smaller companies, on average, lag the already significant under-representation of women at larger companies. All graded members of the Small Blend category received a rating of “D” or lower from As You Sow and most received an “F.” Like many ratings methodologies, the underlying data is not transparent, making it difficult to understand how one grade versus another translates into real world differences regarding a company’s gender equality record.
More importantly, most sustainability ratings, including As You Sow’s, entirely miss the primary way we achieve impact—active ownership. Equality—both gender and racial and/or ethnic diversity—is a priority engagement focus area for Boston Trust Walden and our clients. We routinely use our leverage as shareholders to encourage greater diversity on boards and management, as well as transparency on workforce demographics, to close the opportunity gap within the workplace, strengthen governance, and instill greater public accountability. Each year we follow up with portfolio companies that do not meet our proxy voting threshold of 30% diversity on the board, inclusive of women and people of color, which generally triggers a vote against directors serving on nominating committees.
What do these efforts mean for companies held in Boston Trust Walden’s Small Cap strategy? So far in 2019, we have reached out to 55 companies, or approximately 63% of holdings, on board diversity and equality more generally. Six companies have recently added diverse directors and seven others have expanded disclosure on efforts to improve, often committing to communicate publicly that each director candidate pool will include women and people of color. We recognize we are not alone in encouraging improvement, but our voice matters.
Knowing your investments is important, and sustainability raters have a role to play. But effective active ownership also influences ESG performance, fostering the positive change our clients seek.