Investors considering environmental, social and governance (ESG) factors when investing in small-cap stocks may struggle to find disclosure information at present due to the size of companies in the sector, but many are shifting their focus, according to a United States investment manager.
American Century Investments vice-president and senior client portfolio manager Jim Shore said the inclusion of ESG factors in the analysis of a stock was important as it led to more informed decision-making, but the level and transparency of ESG disclosure was lacking in the small-cap sector compared to the large-cap sector.
“Small caps in many cases don’t have the resources to produce the same level of ESG data or find it too cost prohibitive,” Shore explained.
“We also see that third-party ESG research tends to be more robust for larger companies, which is similar to what we see with traditional stock research.
“There also tends to be a higher percentage of small caps that are founder and/or family-led companies, which often require a more nuanced view towards corporate governance.”
He noted there had been an upward trend in reporting ESG factors in the small-cap sector and the reporting of greenhouse gas emissions, which was a proxy for environmental disclosure.
In 2019, 32 per cent of companies in the MSCI ACWI Small Cap Index were reporting their emissions compared to 60 per cent of large-cap companies in the MSCI ACWI Index, up from 28 per cent and 57 per cent in 2017, respectively, he revealed.
The percentage of small-cap companies producing a corporate social responsibility report has increased from 16 per cent to 32 per cent in the past two years, but was still well behind the 86 per cent of large-cap companies that did the same.
Shore pointed out given the lower levels of reporting, small-cap investment managers would need to take steps to produce their own reports.
“Small-cap managers can implement two important steps and the first is to rely less on third-party ESG data and research providers and develop their own proprietary ESG research. We believe this has the ability to translate to more informed decision-making for clients,” he said.
“Secondly, engagement around ESG topics is critical to encourage more robust ESG disclosure and processes at small-cap companies, and may lead to a better understanding of how companies are managing issues ranging from cybersecurity to supply chain management risks, as well as steps that are being taken to reduce carbon emissions.”
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