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Environment – Social – Governance (ESG) Investing has recently had significant interest by institutional and retail investors alike. The idea of helping society and the environment is a noble goal. A big challenge and question many investors have on ESG Investing is “Is it possible to get outperforming portfolio returns in ESG Investing?” – in other words, is a dual mandate possible – not only helping society and the environment but also targeting outperforming portfolio returns relative to market indices, industry benchmarks and peer funds?

Our firm Cedargold thinks yes it is possible! In fact, our firm literally targets this dual mandate. We focus on all stakeholders, not just shareholders – customers, investors, communities, government, employees and the environment. We see this stakeholder-based dual mandate as the New Investment Paradigm (NIP). We have constructed an actively managed ESG Portfolio in the form of an Index called the Cedar Austrian Economics ESG Index to implement the NIP.

Before we get into describing our portfolio investment process, we suggest reading our recent article on What Makes a Portfolio “ESG”.

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Approach for Targeting Outperforming Returns

Our approach for targeting outperforming returns uses an investment philosophy based on the principles of a unique school of thought known as the Austrian School of Economics, placing emphasis on enduring businesses with high free cash flows, minimal or manageable debt and leverage, innovation, longevity and stores of value. This represents a powerful advantage in an era beset with excessive debt and unsustainable central bank and government policies resulting in adverse unintended consequences.

Our approach assesses seven quantitative factors and seven qualitative factors, distilled from the principles of the Austrian School of Economics (ASE).

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Seven Quantitative Factors Assessed:

  1. ASE Principle – Value is placed upon high, positive cash-flowing businesses
  2. ASE Principle – Value is placed upon limited debt and leverage
  3. ASE Principle – Value is placed upon high earnings per share
  4. ASE Principle – Value is placed upon payout distribution
  5. ASE Principle – Value is placed upon enduring operations
  6. ASE Principle – Value is placed upon owner-operators
  7. ASE Principle – Value is placed upon stable or decreasing float

Seven Qualitative Factors Assessed:

  1. ASE Principle – Value is placed upon environmental, social and governance factors
  2. ASE Principle – Value is placed upon alignment to economic trends
  3. ASE Principle – Value is placed upon alignment to millennial trends
  4. ASE Principle – Value is placed upon uniqueness and scarcity
  5. ASE Principle – Value is placed upon innovation
  6. ASE Principle – Value is placed upon risk mitigation
  7. ASE Principle – Value is placed upon holding purchasing power

We translate the ASE Principles into measurable metrics. This in turn represents seven Quantitative Factors and seven Qualitative Factors to assess businesses for qualification into the portfolio.

Probability and Statistics for an Edge

So how does this approach help us get an edge?

For each of the seven Quantitative Factors, we have identified studies indicating correlation to equity outperformance. This helps to provide an edge towards equity outperformance in the portfolio of businesses. From a probability and statistics perspective, qualifying businesses for the portfolio towards attaining all seven of the Quantitative Factors provides an even greater edge overall. In other words, we add the positive correlation of each factor for all of the seven factors. This approach is our key to targeting outperforming returns in the portfolio.

We conduct extensive research on the levels, ranges and ratios of these Quantitative Factors towards optimization for portfolio performance.

Simultaneously coupling the seven Quantitative Factors with the seven Qualitative Factors, derived from the seven Qualitative ASE Principles that include an overall ESG assessment, presents a powerful integrated approach.

Performance Contribution from ESG Factors and Sustainability Programs

Our team conducts research on optimizing and leveraging from the ESG factors we assess. Furthermore, we assess the sustainability programs that the businesses in the portfolio deliver.

Our approach emphasizes the following results of many studies:

  • Positive link between stronger ESG management and better financial performance;
  • Positive relationship between sustainability with equity performance; and
  • Focusing on material sustainability issues can be value enhancing for shareholders.

It is difficult to assess the contribution of integrating the assessment of these factors and programs toward equity performance in a quantifiable way. However, we estimate that this contribution to the performance is approximately a conservative range of approximately 300 to 500 basis points.

Overall Results

The New Investment Paradigm (NIP) is a difficult challenge to achieve. We think it helps to approach that challenge with an edge derived with probability and statistics. Our actual performance results and back-tested results have historically yielded outperforming returns in our ESG Portfolio. For more information, please see our website.

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