You may have heard the term “ESG” popping up in the news lately.
Environmental, social, and governance (ESG) disclosures provide important metrics to understand how a company’s practices could impact future financial performance. CalPERS uses an ESG framework to assess potential risks to our investments.
For example, under the “social” framework, there is tremendous value in an investor’s ability to verify a company’s data security, as breaches can cause litigation, loss of customer loyalty, and other impacts to profitability.
This kind of information is critical to fulfilling the CalPERS mission of achieving a high rate of return to provide retirement and health benefits to our more than 2 million members and beneficiaries.
Take a closer look at what else is included under the ESG label.
Environmental
Let’s start by focusing on the “E” in ESG, as environmental matters get a lot of attention.
Some examples of environmental reporting factors are climate policies, water use, waste, carbon emissions footprint, and natural resource conservation. All these practices could impact a company’s bottom line, and therefore, CalPERS’ investment earnings.
For instance, governments around the globe have committed to reducing greenhouse gas emissions. Consider if a company’s primary operations produce a significant amount of greenhouse gases. It’s likely they’ll face a drop in revenue or even challenges in meeting their energy demands without switching at least some of their focus to renewable energy.
Take ExxonMobil. Through our work with Climate Action 100+ (PDF), the company now has plans to achieve net zero by 2050 by investing more than $15 billion by 2027 on lower-emission initiatives. We seek to engage the companies we invest in to ensure they’re accounting for long-term risks.
These types of ESG considerations aren’t the radical effort that some critics make them out to be. They’re about identifying risks a company may face due to its impact on the environment.
Social
Let’s define the “S” in ESG: social.
Social is a broad category, but it really comes down to people. Examples of social reporting include information about wage equality, workplace safety and health, human rights, customer satisfaction, and even data protection and privacy.
It’s simple. Negative experiences for employees reduce productivity and increase the chances for workplace litigation, which can impact a company’s bottom line. Data breaches can disrupt operations and hurt customer loyalty, which also can hurt profit potential.
Governance
The “G” in ESG doesn’t often get the big headlines, but it’s foundational to understanding how a company is organized to measure and reduce risks.
Here are a few governance focal points: board of directors composition, accurate and transparent accounting practices, compensation, leadership diversity, and shareholder accountability and rights.
Look at compensation programs. We are a general supporter of what are known as “say-on-pay proposals,” efforts that show a well-structured compensation plan and an appropriate pay-for-performance alignment over the long term. In 2022, we voted “against” 49% of management’s executive compensation proposals for poor pay-for-performance alignment (499 of 1,011 companies). Why should an executive (or anyone) get paid for poor performance? That’s not in shareholders’ best interest.
ESG Is All About the Bottom Line
As a prudent investor, we need to know all the risks companies face. That’s why we need ESG reporting.
And we’re not alone in this desire. In 2022, the SEC issued proposed rules for “The Enhancement and Standardization of Climate-Related Disclosures for Investors.”
The next installment in this ESG series will cover how we’re working with the SEC to improve mandatory reporting. We’ll also look at how, by California law, we’re held accountable to do our own reporting on climate-related financial risks in our public market portfolio.
This article is part of the CalPERS ESG series, which examines ESG basics, hard facts, common myths and specific ways CalPERS has mitigated investment risk using an ESG lens.