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ESG Controversies May Indicate Widespread Company Problems

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How important are ESG (environmental, social and governance) issues to shareholders? Do they really make a difference in investment outcomes? In this issue of Principles and Performance®, we share some insights gained from Parnassus’s 30+ years of researching companies’ ESG records.

ESG Indicators of Company Quality

Parnassus views a company’s ESG profile as an indicator of quality, which is why we review the ESG characteristics of each potential holding. These evaluations focus on five areas: environment, community, customers, workplace and governance.

We aim to avoid those companies that may be headed for trouble. If we find seemingly isolated ESG risks, we will dig deeper. We may engage with management teams to discuss how they are addressing ESG risks. If management is not constructively addressing ESG risks, it is possible that there are larger controversies brewing.

A Jewelry Retailer with a Culture of Discrimination

When researching Signet Jewelers (owner of Zales®, Jared® and Kay Jewelers®) in 2016, Parnassus identified several ESG risks. These included allegations of swapped out gemstones on customers’ jewelry, a lack of supply chain transparency and a gender discrimination lawsuit.

A few months later, it was publicly reported that 69,000 current and former employees had joined a class action lawsuit against Signet Jewelers. In addition to pay discrimination, claims include women being groped and grabbed, solicited for sexual favors in exchange for employment benefits, and required to attend company events where women were expected to publicly undress. Serious internal accounting problems were also discovered. The stock price has dropped by more than half from its high in 2015.

A Pharmaceutical Firm Built on Aggressive Price Hikes

Valeant Pharmaceuticals pursued a strategy of acquiring companies with proven drugs, then raising prices, gutting research and development and laying off employees. Parnassus initiated research on Valeant in 2014, but found this acquisition strategy, as well as their sustainability commitments and tax shelter practices, problematic.

Then Congress launched an investigation into Valeant’s steep drug price hikes. This investigation was followed by the disclosure of highly unethical business practices related to Valeant affiliate Philidor Rx Services, which was redirecting patients from generics to Valeant’s extremely expensive specialty products. The stock fell more than 80% from its peak in 2015.

The Benefits of Rigorous ESG Analysis

The cases of Signet and Valeant highlight the connection between management’s ESG standards and the overall quality of the company. These examples concretely illustrate how a rigorous ESG review process can help identify risks that may be indicators of much larger problems that have not yet been fully revealed.

Mutual fund investing involves risk, and loss of principal is possible.

The views expressed are subject to change at any time in response to changing circumstances in the markets and are not intended to predict or guarantee the future performance of any individual security, market sector or the markets generally, or the Parnassus Funds. Current and future portfolio holdings are subject to risks.