The biggest challenge for any well-meaning ESG investor is to do well by doing good, as the cliché tells us.
But that’s not easy. Given all the pitfalls in the markets, it’s even tougher to “do well” with the constraint of having to favor companies with good environmental, social and governance, or ESG, metrics.
Given the challenges, I thought it would be useful to catch up with a fund manager to get useful tips you and I can learn from.
Andrew Braun, who manages the Pax Large Cap Fund
fits the bill. His fund beats its Morningstar large-blend fund category and Russell 1000 benchmark by 9.5 and 4.5 percentage points over the past year. He also beats those benchmarks by several percentage points over the past three years, according to Morningstar.
The key takeaways: Braun gets his outperformance from three sources beyond the help from his team: 1. Putting money in the path of six ESG mega trends. 2. A small basket of business metrics that lead him to winning companies. And 3. A proprietary ESG rating system.
Let’s take them in order.
The six key ESG mega trends
A fundamental rule in investing tells us it pays to pick companies that get a boost from mega trends. Braun and his team own companies they think get a lift from the following six ESG mega trends. This is a good guide to favorable trends as you research ESG companies on your own.
1. Cloud computing
This counts as an ESG mega trend because it’s energy-efficient for companies to use shared data centers instead of having their own. Thanks to a big strategic shift introduced by Satya Nadella when he was promoted to CEO in 2014, Microsoft
is now at the center of the evolution of cloud computing. Microsoft’s Azure cloud platform recently posted annual revenue growth of over 50%, even though it’s already a giant business with over $20 billion a year in sales.
Another play on this mega trend is Equinix
which runs over 225 data centers in 26 countries through its Platform Equinix. “They’re another facilitator of this very powerful mega trend,” says Braun. This real estate investment trust, or REIT, pays a 1.66% dividend yield.
2. Resource efficiency
Braun and his team at Impax Asset Management look for companies that offer products that save energy and money, or upgrade their equipment to do the same thing.
Here, Trane Technologies
offers heating, ventilation and air conditioning (HVAC) products and services that help building operators reduce carbon footprints. “Installing their equipment is a powerful tool to combat climate change,” says Braun.
Another example is Procter & Gamble
because it sets targets for reduced carbon emissions in its own operations, among suppliers, and for consumers through product offerings that encourage them to use more cold water. The company also ranks high in ESG at Impax because of its gender equality targets.
3. Vehicle electrification and autonomous driving
would be the poster child for this category. But it’s not a Pax Large Cap Fund holding. Instead, Braun favors less glamorous producers of components used in these vehicles. As electric vehicle usage grows, so will these companies.
One example is Aptiv
It sells software and parts that power the brains and nervous systems of increasingly complex vehicles, supporting computing, connectivity, analytical and safety features. Another is TE Connectivity
which sells connectors, sensors and other components for cars and industry.
4. Clean water
Here the emphasis is on repairing the crumbling water infrastructure, improving supply and reducing leakage. Less than 1% of the water on Earth is fresh water, and it’s under threat from pollution, climate change and the destruction of aquifers. Meanwhile, demand is rising. It’s on course to double every 20 years. The upshot is that more and more people are living in areas without enough water.
is a global water technology company that sells products to help deliver water, and analyze and treat wastewater. As the largest publicly traded water and wastewater utility in the U.S., American Water Works
is also a play on the improvement of water supply and wastewater treatment infrastructure.
5. Access to finance
Nearly two billion people do business solely in cash. This makes their lives more difficult because it excludes them from more sophisticated financial products. Access to financial services helps the “unbanked” get out of poverty, save and start businesses. This promotes “sustainable development.” So, it’s an ESG mega trend.
One Pax Large Cap Fund investment on this theme is Visa
because it partners with financial institutions to expand the payments ecosystem and offer products for the unbanked. Another is Voya Financial
which offers services that help people save for retirement.
6. Health-care transformation
The goal here is to go with companies that help bring new therapies and medical devices to market more quickly. Consider IQVIA Holdings
It offers analytical and clinical research services that help biotech and pharmaceutical companies develop and market drugs. IQVIA runs clinical trials. But it also has huge databases of medical records, prescription sales and medical claims. This helps drug developers understand market trends.
Five key business metrics to help you outperform
Braun honed his investing chops at Goldman Sachs Asset Management. He worked his way up to chief investment officer over 20 years after starting as a research analyst. While at Goldman, he earned an MBA at the Stern School of Business at New York University. Given this background, and his record at the Pax Large Cap Fund, we can learn a lot from his short list of favored business and investing metrics, from among the scores available. This could be an entire business school class, but here’s the quick summary.
* Strong and improving return on invested capital. Defined as net operating profits after tax, divided by invested capital, this metric tells you how good companies are at investing. Look for returns above the cost of capital, of course. This screens out managers who are serial destroyers of capital — perhaps because they are more focused on empire building. Any of the tech companies his fund holds are good examples.
* Appropriate use of leverage. Too much will get companies in trouble because it makes the bad times worse. There’s no firm cut off, but generally Braun’s upper limit is four to five times earnings before interest, depreciation and amortization (EBITDA). One example is Equinix, which has refinanced debt over the past two year to bring its leverage ratio down to 3.8.
* Sustainable business model. Braun likes to avoid companies in commodity sectors, and those offering the same products and services as dozens of others. The key question to ask: “What’s special about a business that makes customers want to flock to it?” An example he cites here is Lowe’s
because its size and use of technology help it offer a broad array of the right products at good prices — and keep stores well-stocked.
* Good management incentives. Braun favors companies that link pay to return on invested capital or share value, rather than other metrics that are easier to manipulate, like earnings per share. He also likes companies that link executive pay to ESG progress, like Microsoft.
The Impax ESG rating system
This combines data from external sources, like Sustainalytics, and internal metrics, to rank Russell 1000 companies against industry peers. The weighting of metrics varies depending on the industry. At energy companies, environmental factors will be more important than at banks, for example. This is partly proprietary, but any Impax holdings obviously rank well.
Michael Brush is a columnist for MarketWatch. At the time of publication, he had no positions in any stocks mentioned in this column. Brush has suggested MSFT, PG, TSLA, GOOGL and LOW in his stock newsletter, Brush Up on Stocks. Follow him on Twitter @mbrushstocks.