By Jim Madden, CFA; Tony Tursich, CFA; & Beth Williamson

ESG opportunities with strong returns can be found in a myriad of industries, even among industries with discernible environmental and societal constraints. Approaching a high-risk site From an ESG perspective, we ensure that investments are not made in companies with significant environmental, health and safety risks or liabilities.

Take the chemical industry. Although chemicals are used to make virtually all manufactured goods, they create negative impacts on human health and the environment. These negative impacts can be considered as unpriced externalities that will eventually affect shareholders’ capital. Furthermore, it is important not to be misled by the rankings of the largest chemical companies by ESG rating agencies. For example, at first glance, some well-known chemical companies may appear to be ESG leaders given their high third-party ratings, including AAA or A ratings from MSCI ESG.

Chemicals can have a negative impact on human health and the environment at different stages of their life cycle. Most chemicals use non-renewable resources as raw materials (eg natural gas, coal and coke, minerals, fuel oil and liquefied petroleum gas). These materials are typically hydrocarbons which, when burned, can result in the release of carbon dioxide (CO₂), volatile organic compounds (VOCs) and nitrogen oxides (NOx) which contribute to the formation of ground-level ozone or “smog”. The processing of raw materials can result in the release of hazardous pollutants into the environment. Additionally, hazardous waste is generated as a by-product of manufacturing.

However, perfluoroalkyl and polyfluoroalkyl substances (PFAS) are of great concern. PFAS are a very large class of over 9,000 persistent hazardous manufactured chemicals that includes PFOA, PFOS and GenX chemicals. Since the 1940s, PFAS have been manufactured and used in a variety of industries in the United States and around the world. PFAS are found in everyday items such as food wraps and nonstick, stain and waterproof products. PFAS are also widely used in industrial applications and for firefighting.

PFAS can enter the environment through production or waste streams and are so persistent in the environment that they have been referred to as “eternal chemicals”. Exposure to several PFASs has been linked to a plethora of health effects in animal and human studies. There is toxicological evidence that some PFAS have adverse reproductive, developmental, and immunological effects in animals and humans.

It is important to note that only a handful of companies have produced the basic chemical building blocks for PFAS chemicals, but this short list includes companies with good faith third party ESG. Evidence has been uncovered that although these companies knew of the potential human health risks since the 1960s, these companies denied the claims and ramped up production for decades. As recently as January 2021, spin-offs from one of these companies decided to share over $4 billion in PFAS-related liabilities.

This is just one example of why proprietary research, not third-party ratings, leads to the construction of authentic and credible ESG portfolios. Of course, these ratings can be useful either as a starting point or as confirmation, but they cannot form the basis of an investment decision. We reviewed one of these renowned companies years ago. We were unwilling to include it in our ESG strategies given our view of the company’s poor corporate governance, questionable business ethics and significant environmental liabilities.

Instead, we seek to identify and invest in companies that recognize the value of organic raw material inputs as a tactic for mitigating risks to human health and the environment. Take, for example, the company Croda (OTCPK:COIHF) (OTCPK:COIHY). The majority of Croda’s raw materials are sustainably sourced bio-based materials, including palm derivatives, corn, castor, rapeseed, coconut and sunflower oils. Not only are Croda’s raw materials bio-based, but the company also has some of the strongest supply chain management, audits and certifications in place to ensure long-term supply partnerships and a positive environmental impact.

Croda aims for its bio-based raw inputs to reach 75% by 2030. This is three times the European chemical industry’s target of 25%. Additionally, Croda recognizes its ability to be climate positive. Biobased materials sequester carbon as they grow. Thus, Croda’s supply of bio-based inputs allows the company to minimize its impact on the environment by designing products with a low footprint. Croda’s customers, which include some of the world’s largest personal care, home care and life science companies, also recognize the carbon benefits of Croda’s sustainable ingredients as a means to achieve their own net zero goals. .

Croda: Authentic ESG attributes, backed by action and innovation

In its “Sustainability Report 2021”, Croda notes the following:

Croda can charge a premium on bio-based products and is focused on displacing petrochemical competitors in formulations with a broad “ECO Range” product line in renewable surfactants. Surfactants are useful for creating emulsions and are used in a variety of consumer goods. Surfactants can be formed via compounds derived from petroleum or biomass. Since the input does not impact performance but reduces ecological and health risks, Croda sees a significant increase in demand for these products and realizes a double-digit return on capital. Additionally, with rising ethylene prices, Croda is less exposed to hydrocarbon price volatility, given the company’s reliance on bioethylene*, which can lead to better planning and operational excellence. .

Our team’s due diligence identifies major differences in Croda’s ESG profile compared to those simply rated well by third parties. And, as ESG investors, we believe Croda’s approach offers a greater likelihood of future success. Additionally, we believe that our attention to these types of business fundamentals gives our approach authenticity, credibility and also a greater likelihood of success.

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Editor’s note: The summary bullet points for this article were chosen by the Seeking Alpha editors.