Practical analysis for investment professionals
08 August 2017

Resolving ESG Conflicts: Important, But Not Material?

Institutional investors take note: “Doing Well by Doing Good” is not just a sales pitch private wealth advisers use to court millennial clients. The global economy’s interconnected nature has turned every business decision, even the nonfinancial ones, into forces that can have far-reaching and unexpected effects on investment returns.

Pension plans and other large, long-term investors are acting accordingly.

One such institution is the California State Teachers Retirement System (CalSTRS), which oversees a portfolio of about $208 billion. At the 62nd Annual Financial Analysts Seminar, CalSTRS CIO Christopher J. Ailman discussed the importance of integrating environmental, social, and governance (ESG) considerations into the investment decision-making process.

Ailman began by sharing his frustration with the various terms applied to concerns classified under the ESG heading. “The one that drives me nuts the most is ‘responsible investing’,” he said.

The challenge with these labels, as Ailman sees it, is the way they can divide ESG considerations from normal investment decisions. What do these divisions imply about the normal decision-making process? When companies have groups designated for “responsible investment” activity, Ailman wanted to know, “Who the heck are all these [other] people? Irresponsible investment officers?”

“The words get in the way,” Ailman said. “The words create a problem.”

In fact, Ailman has seen many of the relevant issues already being monitored by investors. “I describe ESG risk as actually long-term operational business risk,” he said, “material operational business risk.” And private equity firms, fixed-income investors, and value analysts are noting those risks. “People won’t use the phrase ‘E,S, and G.’” he said. “But almost always I find I can label those things back into an environmental risk, a social risk, or a governance risk.”

“These risks are business risks that are very long term in nature,” Ailman said. The relevant question is what “long term” means to each investor. “Our typical holding period is 10 years to 30 years,” he said, and in many cases “we’re going to own these companies for so long that we actually have a longer timeframe than their CEOs.” This perspective makes ESG considerations impossible for him to ignore.

“I believe in fiduciary duty,” Ailman declared. But managing ESG implementation in the context of fiduciary duty can get complicated. “It’s nice to try and do other things,” he said, “but the minute you have two goals, you’re serving two masters, and I don’t think you can achieve both as effectively.”

From Ailman’s perspective, focusing on fiduciary duty means that some issues must be set aside if they are not material to the investment decision. “Materiality is still going to be our big struggle when it comes to ESG,” he said, especially with factors that are important but not material to the investment decision. As an example, he shared his experience with a product under development for application on strawberry fields.

“Strawberry fields are actually a big deal in Central California, and particularly along the coast in California, and a lot of the strawberry fields are right up against schools,” he said. Plan participants had contacted Ailman’s office to discuss their concerns about the increased cancer risks associated with the product. But the chemical the new product was to replace burns a hole in the ozone layer.

Not only was CalSTRS being asked to weigh the local risk of chemical exposure against the global risk of ozone depletion, but the company developing the product was based in Japan and owned by a private equity firm headquartered in London. At that point, CalSTRS had to decide whether this single product, out of an entire line of about 100, was truly material to that company and whether that company was material to the private equity firm.

Later in the presentation, a member of the audience asked about palm oil, which has been a source of controversy in Malaysia. “This stuff is not black and white,” Ailman said, noting that decisions around palm oil need to consider possible trade-offs among concerns that include air pollution, water pollution, and increased unemployment. “This is not simple, it is all really hard,” he added. When trying to untangle which issues should affect investment decisions, “you’ve got to start at the level that’s material.”

Separating the important from the material is difficult, but Ailman praised the work of the Sustainability Accounting Standards Board (SASB) in this area. “They’ve identified by industry sector what’s actually material and what’s immaterial.” He noted that in addition to identifying obvious ESG considerations, for any given area, “they’ve already figured out: here are the extra risks you need to be paying attention to.”

When using ESG criteria to analyze investment decisions, Ailman has found that the order of execution does not matter. “We don’t care if a manager does fundamental analysis first, and then factors in ESG, or does ESG first, and then looks at fundamentals. To us, it’s got to be part of the process.”

He also cited the CFA Institute guide to “Environmental, Social, and Governance Issues in Investing,” which finds that “systematically considering ESG issues will likely lead to more complete investment analyses and better-informed investment decisions.” In Ailman’s opinion, a review of ESG issues provides a deeper, more penetrating risk analysis.

Ailman sees ESG analysis as a worthwhile undertaking. Although he has not yet seen attribution analysis that links positive investment returns with ESG screening — he cited Enron and the BP Deepwater Horizon disaster as negative returns that could have been avoided through screening — he said, “I firmly believe it adds to the bottom line.”

If you liked this post, don’t forget to subscribe to the Enterprising Investor.

All posts are the opinion of the author. As such, they should not be construed as investment advice, nor do the opinions expressed necessarily reflect the views of CFA Institute or the author’s employer.


Key Takeaways

  1. CalSTRS CIO Christopher J. Ailman sees many environmental, social, and governance (ESG) issues already being monitored by investors and businesses.
  2. Ailman defines ESG risks as long-term operational business risks, and he notes that some risks will be more material than others when making investment decisions.
  3. In Ailman’s view, fiduciary duty requires a review of ESG issues for a deeper, more penetrating risk analysis. He recommends the work of the Sustainability Accounting Standards Board (SASB) for help identifying relevant issues.


ESG: Does It Add Value?
Christopher J. Ailman

View the full transcript (PDF).

Continuing Education for CFA Institute Members

This collection of products is eligible for 1.0 continuing education (CE) credit. Click here to record your CE credit.

Tell Us What You Think

Conference Collections is a new product from CFA Institute. It features content developed from CFA Institute conference sessions and is a replacement for our Conference Proceedings Quarterly series, which has been retired. Did you find what you were looking for? Was it easy to navigate? Let us know what you think in the comments section below.

About the Author(s)
Peter M.J. Gross

Peter M.J. Gross was an online content specialist for CFA Institute, where he managed blogs for the CFA Institute Annual Conference, European Investment Conference, and Middle East Investment Conference. Previously, he worked at Hampton Roads Publishing Company and at MFS Investment Management. Mr. Gross' articles have been published by Enterprising Investor, City A.M., Seeking Alpha, and The Hook, and his work has been highlighted by Real Clear Markets. He holds a BA degree from Connecticut College.

6 thoughts on “Resolving ESG Conflicts: Important, But Not Material?”

  1. Kellie Craine says:

    I am a huge fan of Chris Ailman. This was a superb presentation and worth keeping for future reference. Thank you for making this available.

  2. Tim Gieseke says:

    Good stuff. I’m involved in assessing governance as an emergent characteristic in organizations, collaborations, etc. and could easily modify it for ESG analysis. Do you see the industry seeking this type of info. For lack of better description I call it a governance style ‘personality trst’

    1. Peter M.J. Gross says:

      Hi, Tim!
      That’s an interesting question. I know that the SASB Materiality Map, which can be accessed here:
      monitors 7 categories under “Leadership and Governance.” You might want to contact them to discuss your idea further.

  3. Scott Tapley, CFA says:

    ESG seems to be, at best, harmless virtue-signaling; at worst, eco-fascism. Everyone believes in good governance, and, as the author notes, “responsible investing.” But the attempt to wrap environmentalism (which is often prone to extremism) and social(ism?) into the equation loses me. Adding those components makes it look/sound/smell like just a further extension of political correctness into the board room. Corporate cultural Marxism that attempts to coerce behavior into what’s desired by the proponents’ self-righteous principles, regardless of any positive investment rationale.

    1. Peter M.J. Gross says:

      Hi Scott,

      you’re bringing an interesting perspective to the discussion.

      The two things I took from Ailman’s presentation were that 1) as a long-term investor responsible for a pool of assets that needed to last across generations, he had to consider the way minor changes will compound across time, and 2) some of those compounding changes will be important enough to affect investment decisions, while others would have to be put aside.

      Which part of his presentation sounded like corporate cultural Marxism?

      1. Scott Tapley, CFA says:

        My comments were intended more as an indictment of ESG in general than his presentation.

Leave a Reply

Your email address will not be published. Required fields are marked *

By continuing to use the site, you agree to the use of cookies. more information

The cookie settings on this website are set to "allow cookies" to give you the best browsing experience possible. If you continue to use this website without changing your cookie settings or you click "Accept" below then you are consenting to this.