We believe that there are three principal factors in measuring the sustainability and societal impact of an investment in a business. We believe these criteria help to better determine the future financial performance of companies. We believe markets exist to allocate scarce capital to its most productive uses. As companies compete for capital, we believe only well managed stewards of capital will prosper over the long term. Good stewards of capital create value, not just for shareholders, but also employees, suppliers, customers and society while minimizing harm to the environment. The small/SMID cap team strives to invest in well managed stewards of capital that make the world a better place. Our investment framework identifies legitimate value creation, where standards of living increase for all, but shuns value transfer, where certain investors gain at the expense of others. The RMB small/SMID cap team views investments from environmental, social and governance perspectives as follows:
Environmental
a. We believe good stewards of capital do not harm the environment therefore, we eliminate from consideration companies with big environmental lawsuits as they represent unforecastable liability. We also eliminate companies with what we consider to be weak competitive positions associated with “high regulatory risk” related to potential environmental liability. Many of the companies we invest in promote “green initiatives;” for example, Columbia Sportswear focuses on extreme eco-friendly, dye-free fabrics in order to meet their green initiatives.
b. We take a practical approach as we seek to own companies that consciously pursue a minimal impact on the environment. The definition of “environmentally responsible” is far from universal. For example, while electric vehicles are considered “environmentally friendly” by many, most of the world’s power to charge electric vehicles is generated by coal, which others argue is worse for the environment than the internal combustion engine. Additionally, the lithium battery technology may be as toxic to the environment as nuclear waste at the end of the battery’s useful life. So sometimes it is not always clear what is better for the environment over the long term. Maintaining a diversified portfolio means we will inevitably stray into some grayer areas of what is or is not considered environmentally responsible. Critical to our investment thinking is that well managed stewards of capital include environmental considerations in their capital allocation decision process.
Social
a. We believe good stewards of capital help their employees grow personally, professionally, and financially in an environment that is blind to religion, ethnicity, and gender. We can assess how well management is doing on these objectives by looking at employee turnover, evaluating the firm’s cultural values, and monitoring whether company management seems to deliver on these values. Additionally, we believe good stewards of capital help their customers, suppliers, and communities in multiple ways. For example, Universal Forest Products’ CEO commented in his 2016 letter to shareholders “Concerned about students graduating from college with mountains of debt and, too often, limited practical skills, we started UFP Business School. The company underwrites the cost of the school, and upon graduation, UFP Business School grads get the first crack at available jobs.”
b. As part of our qualitative analysis, the strategy’s investment team evaluates every firm’s culture as it relates to what they value and how those values get transmuted into how they work with their employees, suppliers, customers, and community.
Governance
a. We believe good stewards of capital operate in an environment where measurable governance and controls ensure that capital allocation, corporate values, and mission get executed faithfully by management. The strategy’s investment team has developed its own Corporate Governance Scorecard that evaluates corporate values, incentives, the board and ownership to monitor alignment with management and owners. Additionally, every company we invest in must demonstrate some effort to “make the world a better place” as we believe companies that do so will increase in value faster than those that do not.
b. Trust and integrity are the pillars on which an effective capitalist system is built. It is the role of the active investor to reward good stewards of capital and to punish those that undermine the role of capital markets. We believe the inclusion of thoughtful ESG principles as well as a deep understanding of social benefits of legitimate value creation enhances our investment process and incorporate them into the structure of the strategies.