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Daniel P. Nielsen
Managing Director - Head of ESG and Responsible Investing
Great Lakes Advisors

Investment managers try to provide their clients with the best risk-adjusted returns possible within their particular strategy mandates. Active managers accomplish this by analyzing individual companies to assess their potential investment return and constructing a portfolio of companies that collectively is expected to provide good returns with low risk.

Increasingly, investment managers are integrating environmental, social, and governance (ESG) information into the investment process with the goal of making better, more-informed decisions that will improve investment performance and reduce portfolio risk. ESG integration is not about values alignment. It differs from socially responsible investing, which is primarily used to align an investor's values with their portfolio holdings through strategies such as exclusionary screening. ESG integration is a tool that can provide portfolio managers with additional insights about companies in which they are considering investing.

Why is ESG integration important? The value of a company consists of its tangible assets, such as factories, stores, and product inventory, and its competitive advantage based upon intangible assets such as brand equity, business methodologies, and logistics systems. In 1975, 83% of the assets of the S&P 500 companies were tangible. In 2015, the opposite was true: 87% of the assets of the S&P 500 companies were intangible.

For example, clothing retailers typically do not own the factories in which their products are manufactured. One source of competitive advantage these companies have is how efficiently they manage their supply chains to ensure the timely delivery of quality goods. Those logistics systems, and the human capital required to manage and continually improve them, are intangible assets that are critical to the success of the company.

Investment managers incorporating ESG factors into their analyses must first determine which ESG issues are relevant to each company. For example, employee health and safety is a more critical issue for coal mining companies than apparel retailers; energy efficiency improvements will have a bigger impact on the bottom line of steel producers than commercial banks. If an ESG issue is not relevant to the valuation of a company, it should
be ignored.

Investment managers must then evaluate how well a company is managing relevant ESG risks or pursuing ESG opportunities, whether that performance is improving or declining, and how it compares to competitors. The result is an enhanced understanding of the company's competitive advantage and likely value.

At Great Lakes Advisors, the asset management division of Wintrust Wealth Management, ESG integration is part of our Fundamental Equity and our Disciplined Equity (quant) strategies. The different nature of these strategies requires different approaches to ESG integration.

The Fundamental Equity analysts conduct an ESG assessment on every portfolio company; within the portfolio, the position size of the companies with the highest ESG scores is increased, and that of the companies with the lowest ESG scores is decreased, reflecting an enhanced understanding of their relative risk.

In the Disciplined Equity ESG strategies, the portfolio managers exclude from the potential investable universe those companies within each sector constituting the bottom 20% of ESG scorers; the portfolio is then constructed with a positive ESG tilt, resulting in an ESG score 10% higher than the benchmark for LargeCap and 15% higher than the benchmark for SMidCap.

Our aim is to make better-informed investment decisions by looking at all of the relevant information about a company. As the nature of company valuations has evolved to depend more on non-financial assets such as human, social, and natural capital, we expect that incorporating ESG information into our investment analyses and portfolio construction processes will help us provide clients with superior risk-adjusted returns.

To learn more about ESG integration and Great Lakes Advisors’ investment strategies, speak with a Wintrust Wealth Management advisor