ESG investing is all the rage today. For any of you not familiar with ESG, it has become synonymous for socially responsible and sustainable investing. Literally trillions of dollars are flowing into what is becoming an asset class in its own right. The folks at MSCI have put together an ESG 101 tutorial that gives a comprehensive overview of what ESG is and why the concept is gaining so much traction.

My sense is that most people, when they think of ESG, are focusing mainly on the “E” and the “S” portion of the acronym. Given the long-term risks associated with climate change and legitimate questions regarding global inequality, maybe it makes sense that the environmental and social aspects would garner the most attention. But what about the “G” or corporate governance part of ESG? Isn’t that as important as it relates to a company’s ability to outperform for the long-run?

At Cove Street, we may not be the hippest, trend-leading kids on the block — if value investing is indeed boring, we are OK being boring — but in reality we have been intensely focused on corporate governance since our founding. This was not due to an aspiration to ride the ESG wave but instead based on what we believe are best practices in long-term investing. Specifically, our three investment pillars are Business, Value and People and it is within our desire to understand the people associated with a company that we carefully scrutinize corporate governance. Every business is run by people so at the end of the day, our belief is that investment success is highly correlated with finding the right people to partner with.

But, how does one go about determining if a management team and Board of Directors are aligned with shareholders? How can you tell if execs are incentivized to make decisions that are simply designed to maximize short-term results at the expense of the future? The value investing luminaries that reside in Omaha tell us about how important it is to find the right managers. But, how in the world, as a minority shareholder with limited access to management, do you know for sure?

The answer, at least from our perspective, is to use a similar, comprehensive due diligence template for all the companies we are researching. We have been using and refining this framework internally for years but for the first time this year, we actually put it on paper to share with the rest of the world. The catalyst for this endeavor was the opportunity to present to a class of UCLA undergrads who are participating in the value investing concentration pioneered by Bill Simon. From what I have seen anecdotally, many investors, when learning about a public company, focus primarily on the business and value and not as much on the people. On the contrary, what we told the UCLA students was that, just because it is really hard to properly understand management’s motivations and competence from afar, that doesn’t mean an investor can ignore the subject altogether. And we gave the students a toolkit that allows them to combine quantitative and qualitative metrics to better understand if a management team and Board are good stewards of shareholders’ capital.

I have attached our presentation — with the scintillating title of Assessing Management and Understanding the Proxy Statement — for your viewing pleasure. You can read it here.

For those of you who want the Cliff’s Notes, here are some key takeaways:

• Capital allocation is really important and analyzing the past can help predict the future
• The proxy statement is a goldmine when it comes to understanding how execs are compensated/motivated
• You can’t assess a management team’s competence without tracking its record of hitting stated goals
• Culture eats strategy for lunch so ignore culture at your own peril
• Understanding the Board’s internal dynamics is hard but can he very helpful
• Spend the time to perform the diligence and always be skeptical of what you are told by execs

We welcome your feedback, comments and questions. Enjoy the presentation!

-Ben Claremon

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