The Institute for Innovation Development interview series seeks to learn from innovative business leaders, uncover innovation best practices, and discover how to apply these insights into the financial services industry.

We recently sat down with Matthew Blume, CFA, portfolio manager and manager of shareholder activism at Pekin Singer Strauss Asset Management -- an independent wealth management firm and advisor to the  Appleseed Fund (APPLX, APPIX) – to learn about their views on business innovation, ESG screens and how they apply them to their socially responsible investment process in their mutual fund.

Hortz: Why do you claim that adding environmental, social and governance screens can further reduce investment risks in your clients’ portfolios?

Blume: Companies that fail to address their environmental, social and governance impacts face substantial legal and regulatory risks, in our estimation.  When a company focuses on improving its safety performance, it reduces the risk of a safety-related lawsuit. When a management team is already looking to improve its own environmental performance, the likelihood of a large environmental-related liability is diminished. When management incentives are properly aligned with shareholders, managers are less likely to risk a company's competitive positioning for a short-term gain of the stock price.

But beyond that, they also risk their reputations and their social license to operate.  These can be existential risks.  Management teams that focus on operating their businesses in sustainable ways that are friendly to shareholders and other stakeholders tend to have a long-term focus.  As long-term investors, this is who we are looking to align ourselves with.  We believe that investing in companies that take a comprehensive and long-term-oriented view of their business will expose our portfolios to less risk of permanent capital loss.

Hortz: Environmental issues are easy enough to understand, but tell us more about what you look for in your social screens?

Blume: We use positive and negative screens in our security selection.  We apply several negative screens in order to simply eliminate certain types of companies that we believe introduce high levels of risk due to the industries in which they operate.  Initially we screen out companies that earn a material proportion of their revenues from alcohol, tobacco, gambling or weapons. In addition, we avoid investment in fossil fuel companies or too-big-to-fail banks. We believe that these types of businesses materially increase the risk of our portfolios because of potential social, environmental, legal or safety issues. These businesses also face substantial reputational risk.  Beyond this initial screening, we also look for positive social attributes that make companies more attractive. We search for companies whose products or services make a positive social or environmental impact and that should benefit financially as a result.  For example, one of our largest holdings is United Natural Foods (UNFI), a natural foods distributor that is an essential part of the supply chain that provides healthy nutrition to consumers.  We expect the company will benefit considerably over time from the long-term trend toward healthier consumer food choices in the U.S.

Hortz: How exactly do you analyze a company for governance? What do you look for?

Blume:  There are several factors that we examine.  We are looking for management teams that have a long-term focus, that are shareholder friendly, that have “skin in the game,” and that have adopted best-in-class governance practices.  With respect to shareholder friendliness, we look at whether cash is returned to shareholders through dividends and buybacks versus making value-destroying acquisitions or management paying themselves exorbitant bonuses. We look at how management responds to shareholder proposals and otherwise engages with shareholders. When we talk about having “skin in the game,” we are referring to having a material financial stake in the long-term success of the company.  We believe that it is very important for managers to own meaningful stakes in the companies that they lead, so we look at insider ownership and transactions.  And then we look for sound governance practices, such as separation of CEO and Chairman, an appropriate level of board diversity, and prudent and aligned compensation structures for management.

Hortz: Part of your process is determining responsible management teams that place “an intense focus on delivering long term value.” How hard is it to find these companies with so much of corporate America focused on next quarter’s earnings and analyst expectations?