One of the knocks on environmental, social and governance investing is that it’s a gray area. But it’s increasingly becoming more of a black-and-white thing as funds, index providers and research shops fine tune their methodologies to quantify the ESG concept.

And this isn’t just an academic argument because more investors—both institutional and retail—are aligning their capital with companies they believe are doing right by one or more of the "E," "S" and "G" principles. So they want to have confidence their money is doing what it’s supposed to do.

According to a recent Morningstar report, there were 392 U.S.-listed open-end mutual funds and exchange-traded funds tied to the ESG, or sustainable investing, theme as of year-end 2020. That was a 30% increase over the prior year and represented a fourfold increase during the past 10 years. The report noted that growth in this category kicked into a higher gear starting in 2015.

The report’s author, Jon Hale, writes that sustainable investing incorporates the full range of ESG concerns while aiming to improve both investment performance and societal outcomes.

Seventy-one such funds came to market last year, which blew away the prior record of 44 new sustainable funds in 2017. And sustainable funds garnered record inflows of $51.1 billion last year, or more than double the prior record set in 2019.

Regarding performance, Morningstar noted that three-quarters of sustainable equity funds last year finished in the top half of their investment category, and 43% generated top quartile returns. Meanwhile, just 6% languished in their category’s bottom quartile.

The TrueShares ESG Active Opportunities ETF (ECOZ) debuted last year and has produced solid performance results. The fund started trading in early March 2020, just in time for the Covid-related market crash. It quickly sank like a stone, but rebounded in the broad equity rally that followed and it sports a one-year return of 68%, placing it in the upper half of its Morningstar assigned large-blend category. Since inception, the fund is up 38%. Its benchmark, the S&P 500 Index, gained 30% during that period.

ECOZ is an actively managed product with a strong emphasis on carbon footprint. The fund is a collaboration between TrueMark Investments and Purview Investments. TrueMark sponsors the TruShares fund family comprising three active thematic ETFs and a suite of structured outcome ETFs. Purview is an independent investment management firm specializing in global investing and impact investing.

“We separated out carbon by itself because we view that as the most urgent issue [of the ESG principles], and we want to evaluate the carbon footprint that companies have,” said Jordan Waldrep, principal and chief investment officer at TrueMark Investments. “We have our own proprietary way of approaching this because we want to look at it from the lens of how we’re thinking about carbon intensity issues.”

He added that carbon emissions is an area that can be quantified with hard numbers.

“The other aspects are important, but they’re less quantifiable,” he said. “All of ESG is kind of shades of gray. There’s no perfect ESG company.”

Carbon Intensity
Waldrep handles the bottoms-up research on the financial side, while Purview CEO Linda Zhang is the primary go-to person on ESG aspects. Zhang digs into ESG-related data on companies provided by the likes of Bloomberg, Sustainalytics and MSCI, and looks at how individual companies report their carbon emissions data.

Waldrep noted the fund’s analysis starts with an industry level estimate for every industry in the S&P 500, and then it looks at individual companies and their carbon intensity scores and their reporting history.

“I’d say 65% to 70% of companies in the S&P 500 are reporting that data across a lot of industries,” he said. “You can combine that with revenue numbers to get a carbon intensity number, which has become an industry standard for getting comparable numbers to show how much carbon is generated by $1 million of revenue.”

The fund employs a process to come up with its own score on carbon intensity by handing out merits or demerits to a company’s carbon intensity rating based on patterns in a company’s emissions history, as well as on the frequency of their reporting.

“If they’ve been reporting regularly, say in four of the past five years, that’s a good number to get an estimate of the carbon intensity they have,” Waldrep explained. “We look at the slope of their carbon footprint, and if their slope is negative that means they’re improving. So we give them a little boost with a 5% reduction in their estimated number. (A lower score is better.) And we penalize them by adding 5% if the slope is positive.

“This emphasizes the companies making the right steps and de-emphasizes the companies that are making the wrong steps,” he continued.

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