Adding Value Through Large-Cap ESG Investing

By Jonathan Bauman, CFA
FEB 16 | 2022
Stylized image of green leaves.

Can my investments do well while the companies I invest in do good? This is a question many investors ask as they consider portfolios that assess environmental, social and governance (ESG) factors as part of the investment process.

Many studies have attempted to answer this question and their conclusions have been inconsistent. Some of the research relies on comparing ESG strategy performance to a broad universe of non-ESG strategies. Other studies compare the performance of a basket of companies with favorable sustainability characteristics to the overall market.

We think there’s a better way to frame the question: Focus on a manager’s ESG integration skills by isolating how each pillar of an investment process affects performance over time.

Measuring ESG Investing Effectiveness

We can measure the impact of ESG integration with an approach reminiscent of the traditional Brinson attribution model. Among other things, this approach can quantify the benefit of being overweight an outperforming sector or underweight an underperforming sector.

Using a similar technique, we can measure the contribution or detraction of being overweight companies with higher ESG scores¹.

We calculate the ESG score using external data sources (e.g., MSCI, Sustainalytics²) to compare companies within each sector and industry based on their management of ESG risks and opportunities. Companies with high ESG scores are viewed as ESG leaders, while those with low scores are considered laggards.

ESG Score

Low end: Laggard, a company lagging its sector peers based on its high exposures and failure to manage ESG risks. High end: Leader, a company leading its sector peers in managing material ESG risks and opportunities.

Source: MSCI. 

Figure 1 illustrates ESG attribution results for American Century Investments’ U.S. Sustainable Large Cap Core strategy (80-100 stocks) and the more concentrated U.S. Sustainable Large Cap Core SMA portfolio (40-50 stocks) since the strategies’ inception more than five years ago.

This attribution analysis clearly illustrates the positive ESG effect for these strategies relative to the S&P 500® Index since inception. The green segments represent the allocation effect from an overweight position in companies with above-median ESG scores combined with an underweight in companies with below-median ESG scores. The market rewarded companies with higher scores during this period, which added value to the portfolio.

Figure 1 | Allocating to ESG Leaders Added Value

Performance Attribution: U.S. Sustainable Large Cap Core Since Inception

Allocating to ESG Leaders Added Value. Performance Attribution: U.S. Sustainable Large Cap Core Since Inception.

Source: FactSet. Data from 7/1/2016 to 12/31/2021. Periods greater than one year have been annualized. Performance in USD, gross of fees. Performance attribution for the SMA is comprised of U.S. Sustainable Large Cap Core strategy attribution from 7/1/2016 to 6/30/2018 and U.S. Sustainable Large Cap Core SMA attribution from 6/30/2018 forward. 

Past performance is no guarantee of future results. Investment returns will fluctuate and it is possible to lose money.

ESG Doesn’t Exist in a Vacuum

ESG is just one of many factors we consider in the investment process as Figure 1 helps demonstrate. The Business Improvement Model Effect measures the impact of investment decisions using our proprietary business improvement score. This score quantifies the fundamental insights our sector specialists consider most important. As shown in Figure 1, an overweight position in companies with higher scores coupled with an underweight in stocks with low scores added value.

The Fundamental/Portfolio Construction Effect also contributed to performance and reflects portfolio decisions that can’t be explained by the ESG or Business Improvement models. This calculation, reflected in the orange segments, is simply the difference between the total excess return over the index and the sum of the ESG and Business Improvement effects. Portfolio construction is critical to managing an integrated ESG portfolio to help ensure that unintended factor exposures—e.g., market capitalization, momentum, volatility or style biases—don’t detract from or overshadow stock-specific decisions.

Done Right, ESG Investing Adds Value

This exercise shows that each dimension of the investment process has the potential to add value to relative performance. It’s important to note that ESG metrics represent only a portion of the total excess return. We believe a quantitative business improvement model that identifies companies with attractive financial characteristics and the insights of an experienced fundamental investment team are crucial drivers of relative performance.

Returning to the original question: Does ESG investing add value? We believe the answer is yes. The attribution examples illustrated in this paper show that for the large U.S. companies in these portfolios, being an ESG leader based on our scoring methodology was a tailwind. We believe this scenario will continue as investors pay closer attention to the material ESG risks and opportunities companies face relative to their peers.

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Jonathan Bauman, CFA
Jonathan Bauman, CFA

Vice President

Senior Client Portfolio Manager

U.S. Sustainable Large Cap Core

The ESG score is calculated using a combination of data from MSCI and Sustainalytics. It compares a company's risk on various environmental, social and governance factors to its sector peers and assigns a score between 0 (worst) and 100 (best) for each company in the peer group.

Sustainalytics is a firm that produces environmental, social and governance (ESG) research on public companies.

Past performance is no guarantee of future results. Investment returns will fluctuate and it is possible to lose money.

When portfolio managers incorporate Environmental, Social and Governance (ESG) factors into an investment strategy, they consider those issues in conjunction with traditional financial analysis. When selecting investments, portfolio managers incorporate ESG factors into the portfolio's existing asset class, time horizon, and objectives. Therefore, ESG factors may limit the investment opportunities available, and the portfolio may perform differently than those that do not incorporate ESG factors. Portfolio managers have ultimate discretion in how ESG issues may impact a portfolio's holdings, and depending on their analysis, investment decisions may not be affected by ESG factors.

Separately Managed Accounts (SMAs) are investment services provided by American Century Investment Management, Inc. (ACIM) a federally registered investment advisor. SMAs are not available for purchase directly through ACIM. Client portfolios are managed based on investment instructions or advice provided by the client's advisor or program sponsor. Management and performance of individual accounts may differ from those of the model portfolio as a result of advice or instruction by the client's advisor, account size, client-imposed restrictions, different implementation practices, the timing of client investments, market conditions, contributions, withdrawals and other factors.

For purposes of compliance with the Global Investment Performance Standards (GIPS®), the Firm is defined as American Century Investment Management, Inc. (ACIM). ACIM claims compliance with GIPS. To receive a complete list of composites and/or a GIPS compliant presentation, contact: American Century Investments | 4500 Main Street | Kansas City, MO 64111-7709 | 1-866-628-8826 |

The opinions expressed are those of American Century Investments (or the portfolio manager) and are no guarantee of the future performance of any American Century Investments' portfolio. This material has been prepared for educational purposes only. It is not intended to provide, and should not be relied upon for, investment, accounting, legal or tax advice.

References to specific securities are for illustrative purposes only, and are not intended as recommendations to purchase or sell securities. Opinions and estimates offered constitute our judgment and, along with other portfolio data, are subject to change without notice.

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