Investment Thesis

At Etho Capital, we believe that Environmental, Social, and Governance (ESG) data and information, when appropriately applied, can improve the financial performance of investment portfolios by identifying companies with better emissions profiles and reduced risks from negative social impacts. We maintain that companies that manage ESG risks are more competitive and can provide better long-term value for shareholders. An in-depth look at the rationale behind our approach is presented below. You can also see the live results of our process by reviewing the performance of the ETHO Climate Leadership US ETF.

smart sustainability
Starts with climate efficiency

Our Climate Leadership Process® started with the discovery that climate pollution can be an indicator for overall operational efficiency and illuminate competitive advantages for a diverse mix of “climate efficiency” leaders throughout the global economy. This is because greenhouse gas emissions are connected to nearly every part of every company's supply chain, so companies that are more efficient by doing more with less relative to their competitors generally also have the lowest relative emissions. We begin by calculating the climate efficiency of thousands of companies. First, we divide each company's total (Scopes 1-3) carbon emissions by its total value. This helps us understand a company’s carbon intensity per dollar invested (CO2e/$). Each company’s climate efficiency is then determined by dividing each company's respective carbon intensity by the average carbon intensity for that company’s particular industry sector. 

Importantly, our calculations include both supply chain greenhouse gas emissions (“upstream Scope 3”) and the climate impacts from the products and services that companies put into the world (“downstream Scope 3”). Scope 3 emissions are largely ignored by ESG reporting frameworks and most ESG strategies. However, supply chain and downstream Scope 3 emissions often account for more than 85% of a company's climate impacts and can be an important indicator of operational efficiency and better management decision-making.

Once a company's Scope 1-3 climate efficiency is calculated, we can identify and compare “Climate Leaders” with “Climate Laggards” in each industry sector. The charts below include several years of financial performance based on the original data sets that led to our discovery of the links between performance and climate efficiency. As illustrated below, “Climate Leaders” outperformed “Climate Laggards” across most sectors and over most time periods.

Climate efficiency and
Financial Returns optimized

Assuming climate efficiency and financial performance are linked, then an optimum climate efficiency level should exist for maximizing risk-adjusted returns. Using the same 2014 data set, we found that in most cases when climate efficiency rises the overall risk-return profile improves. Please, use the interactive chart below to find the optimum level of climate efficiency and financial performance.

unsustainable companies
 compromise performance

Sustainability-minded investors want their investments to reflect their values. They also want robust performance. Our process uses both quantitative and qualitative methods to refine our portfolios to help us identify environmentally unsustainable companies (like coal, oil, natural gas, tobacco) and companies associated with social risks (tobacco, weapons, gambling, etc.). Please, use the chart below to see how our process is applied.

conclusion: Smart sustainability works

To date, conventional wisdom has assumed that ESG-focused investing can compromise financial performance. Yet we have found that environmental, social, and governance data and information, when used appropriately, can actually enhance investor returns. Our analysis of thousands of companies across all industries suggests that climate efficiency may be positively correlated with financial performance and avoidance of unsustainable companies may further enhance returns. When ESG data are skillfully integrated as part of a robust portfolio-construction process, the results can yield substantial performance advantages.