At Etho Capital, we believe investment strategies that incorporate Environmental, Social and Governance (ESG) sustainability in smart, skilled ways will be more competitive and produce better returns over time. To prove that thesis, we developed our Smart Sustainability Process. An in-depth look at the rationale behind our approach is presented below, and you can see how our process is yielding substantial real-world advantages by reviewing the performance of the Etho Climate Leadership US Index and the ETHO ETF.
Starts with climate efficiency
We believe the most efficiently run companies yield both the best near-term and long-term returns. We use climate pollution as a powerful benchmark for overall operational efficiency and competitive advantages, because greenhouse gas emissions are connected to nearly every part of every company's supply chain. Our Smart Sustainability Process starts by calculating over 6,000 individual companies' climate efficiency. We first divide each company's total (Scopes 1-3) carbon emissions by its total value (market capitalization) to calculate carbon intensity per dollar invested (CO2e/$). 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 supply chain (Scope 3) greenhouse gas emissions, which are ignored by most other ESG strategies, despite the fact that supply chain emissions are often over 80% of a company's climate impacts, as well as the biggest indicator of operational efficiency and better management decision-making.
Once a company's climate efficiency is known, we can identify and compare “Climate Leaders” with “Climate Laggards” in each industry sector. The chart below includes several years of financial performance, using a 2014 data set of over 5,000 publicly-traded companies, and shows 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.
Investors concerned about ESG sustainability typically want their investments to better reflect their ideals. We at Etho Capital see another reason to consider ESG sustainability: Performance. Our Smart Sustainability Process uses both quantitative and qualitative screening methods to further refine our portfolios by removing unsustainable companies and industries (like coal, oil, natural gas, tobacco, weapons, gambling, etc.). Please, use the following chart to see how results improve.
conclusion: Smart sustainability works
To date, conventional wisdom has assumed that ESG-focused investing compromises financial performance. At Etho Capital, we are seeing and proving quite the opposite. Our analysis of thousands of companies across all industries suggests that climate efficiency is positively correlated with financial performance, and that avoiding unsustainable companies can further enhance returns. When such findings are skillfully implemented as part of a sound and methodical portfolio-construction process, the results become even more compelling. Simply put, our Smart Sustainability Process can yield substantial performance advantages.