This article was written by Christian Porter, Associate at Kuros Associates.
Responsible investing continues to gain momentum. According to Morrow Sodali’s annual survey, Institutional investors are placing greater importance on the use of ESG (environmental, social and governance) frameworks to identify unique risks and opportunities to help evaluate portfolio decisions. At Kuros Associates, we believe ESG inclusion is here to stay, and will soon develop into the industry norm when constructing an investment portfolio.
In light of the recent health pandemic, global markets reacted violently taking a sharp downturn. One market that has bounced back well after the COVID-19 inflicted market shock, and is producing strong returns in 2020, is the NASDAQ 100, which has returned over 25% Year-to-Date . In light of this, the US market has proven a strong geographical allocation for investors.
With investors flocking to the US market after the country’s robust performance, passive funds can provide an attractive opportunity to access the market. As a result, when investing in an index like the NASDAQ 100 the top 15 holdings, based on market cap, are likely to make up a large portion of tracker funds' assets. However, due to the 'passive' nature of these investment vehicles, funds may not have stringent ESG processes that are able to screen ethical issues and identify sustainability opportunities.
In this article, I analyse the top 15 largest companies, as of August 2020, based on the market capitalization, of the NASDAQ 100 to examine their ESG credentials.
NASDAQ 100 Top 15
Apple
Microsoft
Facebook
Amazon
Alphabet (Google)
Tesla
NVIDIA
PayPal Holdings
Adobe
Netflix
Intel
Comcast
Pepsi Co.
Cisco Systems
Costco
FAANGs
It is of little surprise to see that four out of the top five largest holdings derive from the FAANGs - Facebook, Amazon, Apple, Netflix (Top 11 holding), and Google (Listed as Alphabet). These four firms, excluding Netflix, have a joint market cap of USD$5.4 trillion (roughly equivalent to the combined GDP of the UK and France for the year 2019). The FAANGs offer benefits to society via the way the firm's services have democratised the Internet. Facebook provides a free communication tool that brings people together, Google brings information to every person with an internet connection via its search engine, and Amazon has provided millions of shoppers the most convenient format of e-commerce.
The quartet of businesses has also made strong improvements across the ESG framework, including climate change and resource management commitments. Amazon has ambitiously pledged to become a net-zero carbon business by 2040, with 100% of operations being fueled by renewable energy by 2025. Apple has already achieved 100% renewable energy and now aims to transition all of its suppliers to follow suit. Due to the influence that these firms have, as a result of their large customer bases and supply chains, such commitments to improve sustainability is encouraging to see.
“The NASDAQ 100 has returned over 25% Year-to-Date versus the FTSE 100 which is down 19%. In light of this, the US market has proven a strong geographical allocation for investors.”
The tech giants have also had their fair share of ESG issues, including tax-avoidance, data security, and market abuse tactics to name a few. For example, Google paid only £44.3 million in corporate tax in the UK on their £1.2 billion earnings for the region. The Silicon Valley tech giant, along with other FAANGs stock like Amazon, are taking advantage of tax havens to reduce their tax bills. Although not illegal, it does reduce the Government’s tax revenues that could be used to benefit the wider society.
Another issue that has faced the FAANGs has been concerns about data privacy and cybersecurity. Last year for instance Facebook’s user records were exposed, with 540 million in total found on a database on Amazon Web Services (AWS). The year before this, the firm had faced similar issues in their Cambridge Analytica fiasco, which saw another data breach where personal data was harvested without consent for political advertising.
The rise of FAANGs stocks has been incredible, with each proving to be robust positive contributors to the performance of the index. However, notwithstanding the many successes, these companies have enjoyed, there are still a number of ESG and sustainability challenges to confront as mentioned above.
MICROSOFT
The US$ 1.6 trillion market cap firm is the second largest of the index, returning over 30% since the turn of the year. The firm sells, manufactures, and licenses software products including 365 Office. Looking at the firm's ESG position, Microsoft aims to be carbon neutral by 2030, with climate change and carbon emissions cited as the most important ESG issue to institutional investors. Additionally, the firm also concentrates its efforts towards sustainability, with a focus on water management. Microsoft will also be the first tech campus in Silicon Valley with a Net-Zero Water Certification. It's encouraging to see that the firm is striving to manage its environmental footprint, along with enabling other corporations via its ever-expanding technology platform to act more efficiently.
The main issue facing Microsoft is its current level of diversity, which is below the benchmark for responsible corporations based on the 30% Club. This is an initiative that aims to promote the inclusion of at least 30% of women in C-suite roles (CEO, CFO, and COO) and board directors. In comparison to this standard, in 2019 only 20% of Microsoft's board was female, and 19% making up executive roles.
TESLA
With a current market cap of over US$352 billion, Tesla is an American firm that manufactures electric vehicles (EV). As climate change and carbon footprint become increasingly important issues for society, and as cited the most important to institutional investors, finding alternative means of transport to solve this is key to a more sustainable future. Tesla is paving the way for innovation in this industry, producing a variety of models including branching out into trucks. With electricity a cleaner energy source, EV appears to be a solid ESG investment.
The clear issue facing the firm has been its Corporate Governance setup. For example, Elon Musk back in 2018 was both the CEO and Chairman of the company which led to an imbalance between the firm’s stakeholders and his personal aims. Furthermore, he was forced to step down as chairman after misleading investors over claims that the firm had secured funding for an upcoming project. It is clear to see that Tesla has a track record of poor Governance, which needs to be factored into the investment decision when assessing the company.
NVIDIA
The firm is a technology specialist that focuses on graphic design units (GPUs) for the gaming industry, along with professional markets including artificial intelligence (AI) for Tesla. As a technology firm, CSR policies have focused on cybersecurity, along with concerns around waste management and climate change. What’s also encouraging to see is the way the firm communicates its position to stakeholders, including CSR priority mapping and aligning ESG aims with the UN Sustainable Development Goals (SDGs). However, the biggest way NVIDIA stands out is its social policies around workplace benefits, including adoption and fertility, such as egg freezing, 22 weeks of fully paid maternity leave, and 12 weeks leave for adoption.
The one question mark that stands out for the firm is the businesses that it supports. The Gaming sector, one of NVIDIA’s largest customer bases, continues to cause divides amongst ESG investors. For example, NVIDIA supplies GPUs for extremely violent games including Red Dead Redemption II. This promotion of a brutal lifestyle, although indirectly, can cause concern for responsible investors.
PAYPAL
Another tech giant is PayPal, one of the world’s largest online payment services, spanning across 200 countries and over 350 million active users. The business model of digital payments can be viewed as enhancing sustainability due to reduced waste as we move from the need to hold physical currencies and in turn, the resources required to store and protect these. The firm also aims to democratize financial services, serving the needs of society via its product offerings. PayPal though lags behind some of the other firms mentioned, with only 65% of energy deriving from renewables. The company has also faced issues around data security concerns, including its payment service PayPal Credit, in which they were forced to pay US$25 million worth of refunds for illegally signing customers up to the service without their permission in 2015.
ADOBE
To round out the top ten is Adobe, a software company that focuses on creative design technology, including products such as Photoshop and Creative Cloud. The firm is improving its Corporate Governance, with women and people of colour making up 45% of the firm's board, and was rated 8th on the Fortune's best workplaces for diversity in 2019. The firm also has ambitious energy goals, also aiming to have 100% renewable energy by 2035. However, similar to PayPal, what is not so encouraging is that the current use of renewables is only at 24%, up 6% from the year prior. In contrast, Apple has already reached 100% renewable energy. The firm has encouraging goals but needs to start focusing more resources towards delivering them to provide a more robust sustainable offering.
INTEL & CISCO
The two tech giants focus on products that enable the corporate world, with Intel and Cisco Systems offering networking, computing, and software solutions. These services increase efficiency that facilitates more sustainable business models and improves resource management.
Both firms also have strong ESG prospects. Intel clearly understands the value that ESG incorporation can bring, providing a comparative advantage. The firm has been engaging with investors on responsible investment topics for over 20 years, understanding what areas are important to providers of capital, and formulating business cases for sustainability projects. Taking this a step further, the firm has plotted these issues on a Corporate Responsibility Materiality Matrix to understand the impact of business decisions on a variety of stakeholders.
Intel CSR Report 2018-2019
Both firms have faced their own ESG risks. Intel has had a poor past with its ethical behaviour when it comes to its competitors. A recent example was the anti-competitive actions it took to prevent AMD in the PC processors sector by abusing its market power to force buyers to purchase from them, which led to offices in four EU countries being raided. Additionally, Cisco Systems have their own issues around cybersecurity. In 2019, the firm had to pay $8.6 million to the US Government after selling easily hackable security cameras to the authorities.
COMCAST
Comcast Corporation is a telecommunication company with three main divisions; Xfinity, Sky Group and NBCUniversal. All services fall under the same business strategy umbrella "to create technology and entertainment that connects millions to the moments that matter the most".
The firm aspires to build a more environmentally sustainable company by focusing on four key impact areas to provide sustainable innovation. These are Energy & Emissions, Products & experiences, materials & waste, and engagement & outreach. Key long-term goals include zero emissions, zero waste and 100% renewable energy. These are encouraging as it signals to investors the direction the firm is aiming for and provides the measurability of the firm's sustainable performance.
The business does face a variety of ESG risks including data security, regulations and social media activism in response to content production that causes offence with viewers. The biggest issue, however, is the firm's Governance structure, operating a dual-class structure with CEO Brian Roberts having 33% voting control of the company with less than 1% economic interest. This structure allows the abuse of the voting system to favour one shareholder over the wider concerns of the firm's shareholders and stakeholders. Other issues include the ability for the board to amend company rules without requiring a vote, shareholders' inability to call special meetings and a 75% majority vote to remove Roberts as CEO. With 33% of the voting rights, this is not possible unless Roberts himself voted for his own removal highlighting the bias of the Corporate Governance structure.
PEPSI
Pepsi is probably the major flag on the larger NASDAQ holdings when applying an ESG screen. The firm produces the iconic beverage, served in more than 200 countries. The main drawback here is the sugar content of drinks, with Governments clamping down on production on high-sugar beverages via regulations, including the sugar tax in the United Kingdom (UK). From a responsible investor's viewpoint, the consumption of products that could damage the wellbeing of customers is a no-go. Linking to UN Sustainable Development Goal 3: Good health and wellbeing, sugary drinks have been linked to chronic diseases such as diabetes and obesity and as such, should arguably be excluded from ethical investments.
COSTCO
Rounding out the top 15 with a market cap of USD$ 150 billion, is Costco, an American multinational company that operates membership-only warehouses that offer a variety of consumer cyclical and non-cyclical products. The firm aims to uphold its sustainability responsibilities relating to its supply chain and employees, focusing on business activities that have a positive impact on society. However, the firm has had issues around Corporate Governance, which led to a variety of reforms, including adopting new and updated voting practices. However, concerns still remain for investors, including the inability of shareholders to influence decisions on the appointment of directors on the company’s board.
OUR VIEWS
We believe that as ESG factors become paramount to investors, and with the US market offering strong returns, it is important to conduct due diligence on potential holdings during the fund selection process. By better understanding the responsible and sustainable practices of companies, we can better identify the robustness of the manager's processes before investing.
References
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