CEO and CO-CIO Chris Clark and Director of Risk Management Gunjan Banati discuss the significance of incorporating Environmental, Social, and Governance Factors into Royce's investment process.
Chris Clark: At Royce, the overarching goal of our activities is to drive the best investment outcomes for our shareholders. We are employing environmental, social and governance standards to drive better investment outcomes for shareholders.
What we've found in evaluating companies for over 42 years is that these principles are very important to developing an appropriate enterprise conviction around the companies we invest in and, therefore, giving us the runway to be long-term investors, in businesses.
We continue to believe there's a very powerful influence that this type of analysis can have on our understanding, again, on the long-term sustainability of an enterprise and as we think about investing, we want to continue to arbitrage what is a short-term orientation in the market with the longer-term orientation over which we believe companies can compound value for their investors.
What impact do you think ESG factors can have on performance?
Chris Clark: We think the impact, obviously, will be powerful and for a number of reasons. We think it adds an incremental lens to our understanding of the businesses that we're investing in.
Increasingly, companies are reporting on their activities as it relates to environmental, social and governance standards. So, if it's important to the companies and the management teams, it has to be important to the investors who are evaluating their businesses. Ultimately, we think it has a multifaceted benefit.
We think that it will prove to be a risk mitigator in terms of our confidence in investing in companies and eliminating some of the many risks that are associated with a corporate enterprise. We think by doing that it can reduce volatility. We think it can ultimately drive enhanced returns. And again, ultimately, drive global corporate sustainability, which we think has a lasting opportunity to enhance society as a whole.
What are the differences between Socially Responsible Investing and ESG (Environmental, Social, and Governance)?
Gunjan Banati: Responsible investing has really evolved over time from how it originated in the form of socially responsible investing, which was investing with a social goal, or investing to create a portfolio that was consistent with your social goals. And that was usually implemented through a process of negative screening.
Socially responsible investing has now evolved, and there are many different ways in which you can invest responsibly. But socially responsible investing in its original form was an exclusionary process. It was implemented through incorporating exclusionary screens. And it was done with a willingness to compromise returns, to compromise performance, to achieve that social goal.
ESG integration is quite fundamentally different from that. Environment, Social, and Governance factors, when they're integrated into the investment process, is an inclusionary process, not an exclusionary process.
It's done with the purpose of enhancing returns, as opposed to socially responsible investing, which was done for a social goal, but was done with an understanding that it might actually impact performance.
How will ESG factors affect Royce's investment process?
Gunjan Banati: We believe that incorporating ESG factors into our investment process is an enhancement to the process. It should make our process more comprehensive. The core, the fundamental way in which we invest remains unchanged.
We'll be adding additional factors of environment and social consideration where they are pertinent and relevant to the investment thesis of the company. So incorporating ESG into our investment process we believe is an enhancement to our processes that exist.
We don't expect our process to fundamentally change. We are enhancing it by adding these additional factors, by adding an additional lens of understanding of the sustainability of the companies in which we invest in. And we believe this will make our research process more comprehensive than it was before.
Distinctions among Environmental, Social, and Governance
Gunjan Banati: For those that are familiar with our investment process, they'll know governance has always been integrated in what we do. We've thought about corporate governance in the companies we invest in for a very long time.
Adding the environment and social factors, they were considerations we've always had, but through this new format we hope to incorporate these factors, we hope to take a more formalized approach to incorporating these factors. The way we intend to implement them is to look at the individual industries in which the companies we have invested in are in, and consider which environmental and social factors affected those industries.
So we're doing it through an industry lens. By understanding the pertinent environment and social factors within each industry, it gives us some guidelines. It gives us a framework of the various factors we should think about for the companies that in those industries.