SustainableLife: A holistic approach to active ESG investing

Adam Levison, senior investment director, Oversight & Manager Search, Vanguard.

Core to the environmental, social and governance (ESG) philosophy at Wellington Management Company is the belief that material ESG issues are strategic business issues that could impact the long term-value of a company.

Portfolio managers Nataliya Kofman and Loren Moran, who manage the Vanguard SustainableLife active multi-asset funds, focus on understanding these material issues, and how they will impact a company’s long-term value creation potential, in order to make more informed investment decisions.

Nataliya and Loren believe the integration of ESG considerations into fundamental company analysis can be both return-enhancing and risk-mitigating. They integrate ESG into the fundamental research process and seek to invest in companies that either exhibit ESG leadership or are benefitting from tangible ESG improvement. They believe this can be a substantial driver of long-term value creation.

In particular, companies early in their ESG journey but exhibiting positive momentum are typically well-positioned to benefit from ESG factors. In-depth fundamental research and consistent engagement with management teams and corporate boards allow the portfolio managers to gain a differentiated perspective on these factors, as well as help influence and drive change.

For example, the team views Duke Energy, a regulated US electric power and natural gas holding company, as a strong ESG improver given increasing investment in renewables expansion and the desire to reduce more carbon-intensive sources of power. The company plans to reduce coal to only 5% of its total generation mix by 2030, moving to zero by 2035.

Increasing electrification trends in the Southeast region of the US continue to act as a tailwind to earnings growth, supporting a favourable view on the company’s transformation to a smaller carbon footprint.

Through regular engagements with management, Wellington is of the view that Duke is well positioned to benefit from the transition to renewable energy sources via accelerated earnings growth and an improved valuation.

Exploiting market inefficiencies

Wellington defines sustainable investing as any investment approach that incorporates non-financial environmental, social, governance or other sustainable investing factors in the investment process. The Vanguard SustainableLife active funds integrate ESG through the consideration of material non-financial factors (i.e., climate change, culture or executive compensation) that can impact long-term performance as an input into the overall investment thesis.

For example, portfolio company Eli Lilly is rated below average by some third-party ESG ratings providers. These ratings are related to anti-competitive allegations around drug pricing as well as several product liability lawsuits.

Upon further examination, the portfolio managers view Eli Lilly as a leader amongst biopharmaceutical companies on pricing transparency as it is the only peer to disclose net prices for the entire portfolio as well as specific products. Wellington continues to monitor product liability lawsuits, however, it is worth noting that Wellington sees the company’s quality unit exhibiting best practice within the industry.

Overall, Nataliya and Loren share a very similar investment approach focused on a long-term horizon and low turnover. Their approach is in contrast to short-term-focused investors who do not take the time to understand a company’s long-term strategy or have the resources to routinely meet with boards to discuss issues such as capital allocation decisions and corporate culture.

Through thorough research and by investing the time in getting to know the companies well, often over many years, Wellington is well positioned to engage with companies to better understand and advise them on a long-term basis.

It is this depth of knowledge which allows them to fully appreciate the changes a company is making to meet their long-term sustainability targets. This is what gives them an edge as they look to influence positive change while helping to deliver long-term, sustainable value to investors.

Investment risk information

The value of investments, and the income from them, may fall or rise and investors may get back less than they invested.

Some funds invest in emerging markets which can be more volatile than more established markets. As a result the value of your investment may rise or fall.

Investments in smaller companies may be more volatile than investments in well-established blue chip companies.

Reference in this document to specific securities should not be construed as a recommendation to buy or sell these securities, but is included for the purposes of illustration only.

Funds investing in fixed interest securities carry the risk of default on repayment and erosion of the capital value of your investment and the level of income may fluctuate. Movements in interest rates are likely to affect the capital value of fixed interest securities. Corporate bonds may provide higher yields but as such may carry greater credit risk increasing the risk of default on repayment and erosion of the capital value of your investment. The level of income may fluctuate and movements in interest rates are likely to affect the capital value of bonds.

The Funds may use derivatives in order to reduce risk or cost and/or generate extra income or growth. The use of derivatives could increase or reduce exposure to underlying assets and result in greater fluctuations of the Fund's net asset value. A derivative is a financial contract whose value is based on the value of a financial asset (such as a share, bond, or currency) or a market index.

Some funds invest in securities which are denominated in different currencies. Movements in currency exchange rates can affect the return of investments.

For further information on risks please see the “Risk Factors” section of the prospectus on our website at https://global.vanguard.com.

Important information

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