KPIs in Action: Driving Sustainable Business Models
Explore the role of KPIs in enhancing sustainability efforts and economic imperatives for high-quality value companies.
Key Takeaways
Pursuing long-term sustainability offers compelling opportunities for high-quality value companies, and these efforts can vary by sector.
Our approach seeks high-quality companies fully committed to sustainability, those starting to improve or those under the radar in this area.
By relying on KPIs to drive peer-group comparisons, we apply a methodical framework to identify and monitor companies that meet our criteria.
American Century’s Global Value Transition strategy reflects an active collaboration between our Global Value and Sustainable Research teams to build a portfolio of high-quality value companies improving their sustainability profiles. The strategy looks for companies that understand the economic imperatives of transitioning to a more sustainable global economy and the opportunities that may result from improving the sustainability of their operations and business models.
Mapping sustainability-related key performance indicators (KPIs) to companies that meet our quality value criteria is central to our Improvement Pathway Framework.
Purpose of the KPI Framework for Sustainability
Using KPIs as a foundation, we created a robust approach to achieving the dual accountability that guides our portfolio construction and management. By providing clear, tangible sustainability metrics for our analyses, the KPIs establish internal accountability for ensuring sustainability is embedded into the investment process. They also guide the stock selection process by highlighting companies with clear Improvement pathways that distinguish them from industry peers.
The KPIs guide our active ownership efforts with each portfolio company by helping our analysts monitor a company’s progress and identifying critical areas for engagement activities. Finally, the KPIs create external accountability by improving transparency and providing clear reporting metrics.
The Investment Process: Integrating Quality and Sustainability
Integrating quality and sustainability is the strategy’s underlying investment philosophy. Our Quality Value and Sustainable Research teams filter and funnel investment candidates through a five-step collaborative process to produce the actively positioned Global Value Transition portfolio.
Identifying Quality Companies. We find companies that meet our definition of quality, which includes:
• Potentially attractive and relatively stable returns on capital.
• Expectations for sustainable returns on capital over time.
• Relatively low leverage.Identifying the Improvement Pathway. We then use KPIs to identify companies that meet our improvement pathway criteria, classified by themes (as described below) that recognize differences across sectors and the various ways companies can improve their sustainability profiles.
Fundamental Research and Valuation. We regularly monitor the filtered universe of high-quality companies using fundamental analyses and risk/return profile assessments.
Portfolio Construction. Identifying what we think are the best relative risk/return opportunities within the high-quality universe drives portfolio allocations. Position sizing is dynamic, and we consistently monitor risk controls and portfolio guidelines.
Transition Engagement and Escalation. The Global Value and Sustainable Research teams develop a robust transition engagement plan for each portfolio company. The plan and the company’s progress are assessed over time under a defined framework.
Defining an Improvement Pathway for Sustainable Growth
Identifying each company’s improvement pathway is critical to our process. To do so, we classify companies into one of four major themes. This approach acknowledges that different sectors and companies are at various stages in their sustainability transitions.
These classification themes and the KPIs discussed below help us understand each company’s sustainability profile and characteristics in the appropriate context to establish a credible and tailored investment thesis. The approach also supports broad sector diversification, distinguishing this strategy from others, such as “best-in-class,” which may result in greater concentrations in certain sectors.
The four improvement pathway themes include:
Sustainability Committers. These companies are actively committed to enhancing their sustainability profile or improving their customers’ sustainability, as evidenced by ongoing financial investments to support these efforts.
Operational Improvers. Firms in this category are working diligently to address issues temporarily damaging their sustainability profile.
Unrecognized Leaders. These companies are making notable sustainability efforts but not receiving proper credit for their leadership in this arena, often due to industry-specific overhang.
Sustainability Enablers. This category includes companies whose products or services are indispensable to a sustainable economy, even if the nature of their business masks this reality.
Identifying Sustainable KPIs
We use a mix of KPIs to satisfy a range of essential criteria. This allows us to assess issues that are key to the strategy and create a diversified portfolio of companies committed to making a sustainable transition in ways that reflect their industry characteristics. Our KPIs include:
Material. Our Quality Value and Sustainable Research teams identify material sustainability considerations relevant to each industry or sector.
Industry- and Sector-Specific. Analysts consider metrics that capture material sustainability issues and apply to most or all industries and sectors, as well as industry- and sector-specific issues and metrics, to develop an exhaustive set, or “bench” of KPIs.
Designed to capture both the breadth and depth of sustainability issues. By identifying material sustainability issues at an industry or sector level, we can go beyond a narrow focus on carbon emissions. Thus, we can identify companies committed to making a sustainable transition in material and relevant ways to their industries.
Quantitative and Qualitative. Given the variability in sustainability-related data, including varying levels of company disclosures, our sustainability-focused KPIs include quantitative and qualitative metrics.
Applied from the bottom-up, based on top-down guidance. After mapping each company in the portfolio to an improvement pathway theme and materiality-focused KPIs, we apply a bottom-up approach based on top-down guidance, allowing for the critical element of flexibility conducive to identifying opportunities based on company-specific improvement pathways and overall context.
KPI Framework: Energy Sector Case Study
Given the environmental impacts of the traditional energy sector, we are committed to taking an active ownership approach with energy companies in the Global Value Transition strategy. We believe this approach is better suited to achieving real-world outcomes than a divestment strategy.
While not providing a complete list, Figure 1 highlights some considerations guiding our process.
Figure 1 | Subset of Energy Sector KPIs
Quantitative KPIs | Qualitative KPIs | |
|---|---|---|
Energy Sector | • GHG emissions intensity | • Executive compensation structure |
Source: American Century Investments.
In this example, we apply the Improvement Pathway KPI Framework to explain why the Global Value and Sustainable Research teams believe TotalEnergies SE (TTE) has attractive characteristics.
TotalEnergies SE (TTE) is France's largest integrated energy company. Given its aggressive efforts to decarbonize its business, we classify it as a sustainability committer. See Figure 2.
TTE is accelerating its investment in more sustainable energy sources, transforming its overall business, and shifting its energy mix. Low-carbon energy continues to grow as a share of its total energy mix and net investments, while increased renewable energy capacity enables the company to execute its integrated energy strategy.
TTE also monitors the entire lifecycle of its energy product sales, covering the full spectrum of Scopes 1, 2 and 3 emissions, considering the lifecycle carbon intensity of its sales, and setting reduction targets, providing further visibility into the company’s sustainability transformation.
Figure 2 | TotalEnergies SE Improvement Pathway
Sustainability Committer
Data from 1/1/2019 – 12/31/2023. Source: American Century Investments.
We can apply this framework to distinguish TTE from another energy company in the Value team’s quality universe that wouldn’t warrant inclusion as an investment candidate because it lacks a clear improvement pathway.
Diamondback Energy (FANG) is a large U.S. oil and gas exploration and production company. Although it meets the Value team’s quality criteria, it doesn’t have a clear improvement pathway to sustainability. See Figure 3.
FANG focuses solely on fossil fuel products, with little indication of material plans for operational or strategic transitions toward more sustainable energy sources.
The company’s emissions footprint disclosures lag behind its peers, reducing the historical visibility into the full lifecycle of its operations and products. FANG first reported its Scope 2 emissions in 2020 and Scope 3 emissions in 2022.
Figure 3 | Diamondback Energy Improvement Pathway
No Clear Improvement Pathway to Sustainability
Data from 1/1/2019 – 12/31/2023. Source: American Century Investments. Note: FANG didn’t report Scope 2 emissions before 2020.
This example shows how the Improvement Pathway Framework identifies companies with improving sustainability profiles or characteristics. It also demonstrates a clear distinction between a sustainability committer (i.e., TotalEnergies) and energy sector peers that may not show signs of pursuing sustainability-oriented improvements or opportunities.
KPI Framework: Consumer Staples Sector Case Study
Implementing the “breadth and depth” design principle, our KPIs allow the strategy to diversify, thereby avoiding the “carbon tunnel vision” that other investment strategies focused on a sustainability transition often develop. The consumer staples sector offers a clear example of this perspective.
We strongly believe this sector has the potential to deliver attractive returns while driving positive real-world sustainability outcomes. For example, certain food companies with extensive value chains are elevating topics, including supply chain oversight, human capital and biodiversity, in identifying key sustainability considerations.
We can apply our framework to a company in this sector to highlight its improvement pathway:
Barry Callebaut (BARN) is a global leader in manufacturing chocolate and cocoa products. Given its efforts to improve sustainable sourcing practices, address the use of child labor and encourage good farming practices across its value chain, we classify the company as an operational improver. See Figure 4.
The company is increasing its use of sustainable cocoa/chocolate and the sustainable sourcing of non-cocoa raw materials.
The company is working with its direct-source farmer groups to address concerns about child labor. Over the past several years, some of these groups have implemented systems to better monitor and address child labor issues.
Figure 4 | Barry Callebaut Improvement Pathway
Operational Improver
Data from 1/1/2019 – 12/31/2023. Source: American Century Investments.
Active Ownership and Sustainability Engagement
A buy-or-sell decision alone doesn’t drive positive real-world outcomes. This reality reminds us that we view the Global Value Transition strategy as an internal collaboration between the Global Value and Sustainable Research teams and an external partnership with each company held in the portfolio.
Transition Engagement and Escalation
As active owners, we believe that achieving our objectives requires accountability. Our Transition Escalation process represents an additional step to ensure we actively monitor KPIs and use the engagement and proxy processes as levers to encourage companies to progress along their improvement pathways. We believe these examples demonstrate the benefits of regular company engagement:
Emerson Electric (EMR) had significant exposure to oil and gas relative to its peers, generating concerns about diversifying its business, especially sustainability-related strategies. The company is now significantly growing its sustainability backlog and expanding its digital transformation business through organic growth and strategic acquisitions.
This highlights EMR’s innovative approach to reducing its environmental impact while improving manufacturing productivity and energy efficiency. The company is also enhancing its disclosures to provide more visibility into these efforts.MSC Industrial Direct (MSM) is better aligning its executive compensation program with shareholder interests. The company first replaced stock options with performance-linked stock units (PSUs) and then increased the overall weighting of the PSUs within the program. It subsequently incorporated a Return on Invested Capital metric to enhance the performance-linked component.
Using KPIs as a core part of our analytical framework provides objectivity and accountability and informs our active ownership efforts. It also allows us to monitor the progress of companies held in the portfolio systematically. This framework helps to identify each company’s improvement pathway, driving productive engagement with company management and encouraging continued progress in the transition to greater sustainability.
Authors
Diversification does not assure a profit nor does it protect against loss of principal.
Many of American Century’s investment strategies incorporate sustainability factors, using environmental, social, and/or governance (ESG) data, into their investment processes in addition to traditional financial analysis. However, when doing so, the portfolio managers may not consider sustainability-related factors with respect to every investment decision and, even when such factors are considered, they may conclude that other attributes of an investment outweigh sustainability factors when making decisions for the portfolio. The incorporation of sustainability factors may limit the investment opportunities available to a portfolio, and the portfolio may or may not outperform those investment strategies that do not incorporate sustainability factors. ESG data used by the portfolio managers often lacks standardization, consistency, and transparency, and for certain companies such data may not be available, complete, or accurate.
Sustainable Investing Definitions:
Integrated: An investment strategy that integrates sustainability-related factors aims to make investment decisions through the analysis of sustainability factors alongside other financial variables in an effort to make more informed investment decisions. A portfolio that incorporates sustainability factors may or may not outperform those investment strategies that do not incorporate sustainability factors. Portfolio managers have ultimate discretion in how sustainability factors may impact a portfolio’s holdings, and depending on their analysis, investment decisions may not be affected by sustainability factors.
Sustainability Focused: A sustainability-focused investment strategy seeks to invest, under normal market conditions, in securities that meet certain sustainability-related criteria or standards in an effort to promote sustainable characteristics, in addition to seeking superior, long-term, risk-adjusted returns. Alternatively, or in addition to traditional financial analysis, the investment strategy may filter its investment universe by excluding certain securities, industry, or sectors based on sustainability factors and/or business activities that do not meet specific values or norms. A sustainability focus may limit the investment opportunities available to a portfolio. Therefore, the portfolio may underperform or perform differently than other portfolios that do not have a sustainability investment focus. Sustainability-focused investment strategies include but are not limited to exclusionary, positive screening, best-in-class, improvers, thematic, and impact approaches.
The opinions expressed are those of American Century Investments (or the portfolio manager) and are no guarantee of the future performance of any American Century Investments' portfolio. This material has been prepared for educational purposes only. It is not intended to provide, and should not be relied upon for, investment, accounting, legal or tax advice.
References to specific securities are for illustrative purposes only and are not intended as recommendations to purchase or sell securities. Opinions and estimates offered constitute our judgment and are subject to change without notice.
No offer of any security is made hereby. This material is provided for informational purposes only and does not constitute a recommendation of any investment strategy or product described herein. This material is directed to professional/institutional clients only and should not be relied upon by retail investors or the public. The content of this document has not been reviewed by any regulatory authority.