There is some confusion around the terms and methodologies behind SRI (socially responsible investing), ESG (environmental, social, governance) and impact investing. If they all exist on the same spectrum, where does one begin and the other end? Maybe even more interesting a question is should we be looking at them separately at all? While these approaches have initially seemed as maverick exercises and an eclectic approach to stock selection, in today’s business environment, shouldn’t they really be seen as part of the natural evolution of the investment analyst’s corporate management research process? Do they not add a series of new astute business analysis factors that will add value and another dimension of “margin of safety” to clients’ portfolios?

To answer these and other questions on a rapidly mainstreaming investment approach, the Institute for Innovation Development reached out to Norman Conley III, CEO and CIO of JAG Capital Management—an independent, 100 percent employee-owned registered investment advisor headquartered in St. Louis, Missouri that has a long history of working with investors focused on SRI and ESG issues.

Bill Hortz: What do you see as the difference between ESG, SRI and Impact investing and is there a different investment methodology between them?

Norman Conley: JAG Capital Management has been a socially conscious investor throughout its 70-year history. For a firm with many decades of experience in this area, it’s curious to see scores of our fellow asset managers newly embracing social concepts. We see ESG and impact investing as an adaptation of what we’ve historically tried to accomplish on behalf of our clients.

Socially responsible investing (SRI) methodology limits the size of a potential investment universe by omitting the stocks of companies operating in businesses deemed to be socially offensive. Stocks in the tobacco, liquor and weapons manufacturers and distributors are frequent omissions. There have been times through the decades when eliminating investment choices in these areas has impacted investment performance to the negative. Partially as an outcome of those times, our experience is that clients have gotten increasingly specific on areas to avoid. For example, weapons would be refined to “offensive weapons,” or liquor omissions would be amended to only exclude “hard liquor.”  These exclusions have increased the size of the SRI investment universe, but added to the confusion in the category.

Environmental, social and governance (ESG) has flipped the process for social investment screening from exclusion to inclusion and from a simple screen to a core business due diligence exercise. The ESG philosophy broadens both the social investing and business management considerations. The method essentially says that all companies have some social merit, and that one can and should target investments to those with more social merits than others; that have a more expansive stewardship built into their business decisions and management processes. No companies are omitted from consideration, but nearly all companies in an investment universe are scored and ranked according to their social accomplishments in key areas.

Impact investing constitutes shareholders and some investment managers attempting to encourage corporations to improve outcomes for their employees, customers, and communities. This can be accomplished through providing capital, voting proxies and outright activism. While JAG prefers to focus on due diligence instead of activism, we do insist that our clients have equal voting rights. One avenue for influencing corporate management teams is through voting shares. Many public companies, including some big ones like Facebook and Google, have A and B share classes, where A shares are available to the public and B shares have voting control. Meaningful voting rights are necessary for impact in our opinion.

Hortz: Why and how have you chosen to integrate ESG into your investment process and firm brand?

Conley: SRI has been integrated into our investment process for decades, and it continues to be integral to what we do today. However, as ESG processes and tools have emerged, we have adopted them into our research platform. We created a section of questions in our qualitative research interface to require our analysts to consider ESG issues and incorporate ESG into individual company analyses. JAG believes that such social investment considerations lower risk in our portfolios.

Alongside our development of social investing tools, we work to improve our own corporate social presence. JAG is a signatory to the UNPRI, the United Nations social responsibility agreement, which requires us to report on our sustainable investing activities, and we are a member of the Midwest Coalition for Responsible Investment. Moreover, we have drawn focus to our own impact, especially related to local charity work.

Hortz: What major issues or areas of corporate activity do you see as the most effective in determining how corporate managements are doing on these issues?

Conley: This is, we think, a big point of differentiation for us relative to other social investors. JAG believes that if corporations are developing and supporting employees that turnover should be low. We believe that if corporations are conserving resources that margins should be advancing as a result.  We believe that if managements are acting in an ethical manner that legal and regulatory costs should be falling. In short, we believe in measuring corporate financial reports to find proof that their social efforts are producing tangible results.

Hortz:  Are there any studies you have done that you would like to share with us that you feel are helpful in developing and implementing SRI/ESG investment strategies?

Conley: We believe JAG is a thought leader in the social investing area, and we publish some of our own research. Most recently, we distributed a report questioning how investors hoped to make an active contribution to social issues by investing in a passive social index. We know that index and ETF investing is popular, but we wonder aloud how those structures make sense in social investing areas. Investors are neither directing capital nor are they capable of impacting management teams by putting money into a passive investment product. You could call that research self-serving as we are an active manager, but we believe in social purpose, and we do not see a way to achieve a social purpose in a passive investment product.

Hortz: What other tools/processes are you using to implement your ESG investment process? Are there enough tools for asset managers to truly identify companies that can deliver on their ESG processes?

Conley: SRI exclusions are hard coded into JAG’s factor model, and we previously described our analyst interface that requires the analysts to address social considerations in the normal course of their analysis. In addition, JAG offers an ESG Impact strategy in which we select certain ESG data from an outside vendor, and we integrate that ESG data directly into our factor model. As such, ESG is integrated into our investment process, and it is a critical part of every investment decision.

To address your question on tools, JAG believes that information is sufficient in the marketplace and that there are several good vendors of social investing data. We believe that we have an advantage given our history in how to utilize that data. Vendor data though has a pronounced large cap bias in our opinion. In addition, vendors seem to be very active in their weighting choices of ESG sub-factors (factors that ultimately make up the aggregate scores). JAG has a method to cut through those outside emphases and biases.

Hortz: Are there third party firms and systems that analyze and rate ESG/SRI/Impact funds and do you feel they gauge well what competitors in this space are comparatively doing?

JAG decided long ago to promote its Large Cap Growth equity strategy as a regular large cap growth fund instead of as the SRI product that it is. We did not (and do not) think that using SRI restrictions and incorporating ESG/impact investing elements to our core investing process provides an excuse to compare ourselves to a different benchmark than the Russell 1000 Growth Index. We are likely being evaluated on a different basis than our peer group, but that has been our choice. 

In a recent development, we have had growing pains with one of the new tools in the social investing market. We were disappointed with the newly launched Morningstar Sustainability Rating for our mutual fund. We suspect our active investment choices and custom social scores do not align with their methodology. We sense that the tools to measure ESG funds are not adequate at this time. 

Although SRI investment styles have been around for a long time, ESG investment styles are sufficiently new that the market is short on benchmarks. For example, JAG is a social growth equity investor, and direct benchmarks for our investment style don’t really exist. 

Hortz: What are you doing to bring more clarity and transparency to ESG investing?

Conley: JAG sees social progress as an essential and integrated element of our investment strategy. We do not think SRI or ESG investing will ultimately prove useful as an overlay or an add-on to an existing investment process. They will have to be fully integrated. We hard coded what we believe—social choices which improve financial returns will make investors more money.

At this stage in the evolution of social investing, JAG thinks we can set an example for the industry. We have started a process to bring more transparency to social investing processes through expanded thought leadership, sharing of research and increasing advisor/industry engagement. We believe that safety, conservation, and ethics are universal, achievable and measurable social outcomes. We would like to be part of educating advisors and clients to find this common ground.

Hortz: How would you recommend advisors with clients interested in SRI/ESG/Impact investing to best choose among these areas and what are the most important criteria to base their choices on?

Conley: For advisors with clients interested in SRI/ESG/impact strategies we suggest they might find their clients’ social inventing comfort zone seeking answers with them to these questions:

SRI—What companies would you exclude from investment consideration for social reasons?

ESG—Which companies have the best social characteristics in each ESG sector?

Impact—At which companies can I make a difference in social policy?

Separately, we have had several difficult conversations with clients about virtue signaling. Virtue signaling, by our definition, is when a corporation makes a socially popular decision which hurts the business. Here is one of many examples: Starbucks rejected plastic straws (socially popular) but replaced the straws with higher plastic content and more expensive lids (environmentally and financially negative). We believe that virtue signaling is the enemy of social investing, and we endeavor to gather support to oppose socially popular, financially negative corporate decisions.

At JAG Capital Management, we feel strongly in SRI/ESG/Impact investing methodologies as a natural evolution and powerful tool in core investing thinking. By supporting a more thorough, modern, corporate management analysis perspective, it can only help refine the stock selection process and provide more risk management benefits. As such, a well integrated "social due diligence" mindset built into the investment process addresses any of your clients that believe in investing in well run 21^st century companies and value a strong risk management approach.

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