ESG Investing – Who Cares?

Lot’s of people, actually.

ESG investing, otherwise known as investing with consideration of environmental, social, and governance facets of a company, is a recent “hot topic” in the financial world.  A comprehensive collection of plan sponsors, fund managers, and consultants have focused their attention toward understanding and implementing ESG investing. For both moral and economic incentives, popular topics include: reduced emissions and climate impact, environmental reporting and disclosure, human and safety rights, product quality, responsible lending, corporate philanthropy, shareholder rights, and “sound” corporate governance practices.

Are you thinking to yourself: what rational investor would be willing to compromise return in order to achieve some sort of moral gratification? You’re not alone. This is a chief contention from the ESG skeptics.

Why the buzz now? We have seen numerous (arguably unsuccessful) attempts since the 1970’s.

A common misconception is that ESG today is simply a resurgence of a prior fad.  ESG investing has evolved from previous iterations; ESG today represents an outgrowth from restricted lists of the ’70s.  No longer is the focus on industry and sector constraints, but rather on incorporation of ESG factors into the investment process. Nonetheless, there are hurdles to widespread implementation of ESG investing.  Among others, fiduciary duty, lack of standardization, difficulty of quantification, mixed data, and a somewhat limited reward from clients (at least thus far).

But the proponents are growing in volume…and louder too.

On the West Coast of the U.S., California Public Employees Retirement System (CalPERS) and California State Teachers Retirement System (CalSTRS) are leading the charge. Anne Simpson, Director of Global Governance at CalPERs, comments on managers who fail to recognize the importance of ESG investing:  “They will lose mandates.  It’s that simple.”  CalSTRS has recently required managers to research and assess 21 risk factors in all of their holdings, including securities regulation, political and human rights, and auditing and environmental concerns. Christopher Ailman (CIO) states, “At first managers were reluctant, but we’re a big client and they are starting to do it.  And if they see it from us, they are going to see it from more and more people”.

Leading the private equity pack, KKR, Carlyle, and CBRE Global are publicly advocating the importance of ESG.  Last month, KKR formalized a policy which applies an ESG review to all prospective fund investments.  Carlyle recently hired its first chief sustainability officer, Jackie Roberts, and CBRE is dedicating efforts to their real estate investment property portfolio; as such, each investment must pass a sustainable building and energy efficiency review.

The consultant world is following suit. Jessica Matthews of Cambridge publicly commented on a recent surge in ESG-related demands in RFPs and mandates. Callan Associates has formed a dedicated ESG research team, dedicated ESG task force, and has purchased MSCI ESG data to enable scoring of portfolios and companies. Mercer, who developed ESG ratings in the late 2000’s, is taking an extremely close look at ESG. In 2010, Mercer integrated their previously established ESG ratings into the investment manager vetting process.  Currently, 5,000 strategies have received ESG ratings from Mercer, with ten percent holding the highest ratings. “The ESG ratings are a complement to the conventional manager assessment, and while they are not an absolute determinant of an overall manager rating, if there are two A-rated managers, the one with the higher ESG rating will be preferred” (Nick White, Global Director of Portfolio Construction Research, Mercer).  Craig Metrick, Mercer’s Principal and U.S. Head of Responsible Investment, comments: “The central thesis remains that ESG issues are associated with risks, not just to companies but to sectors, portfolios, and the broader market. Managing these risks in a way that keeps focus on long term financial returns is increasingly seen as a fiduciary duty that needs to be managed by investors”.

Although once considered a fad, ESG investing seems to be drifting toward mainstream.  The question lies in how strong the belief and implementation will become. Presumably, high quality managers are already incorporating ESG factors in varying degrees into their long-term risk-assessments. Perhaps now it becomes a game of effective communication.

Investment managers that cannot effectively convey the way in which they are considering and implementing ESG will lose.

5 thoughts on “ESG Investing – Who Cares?

  1. Unfortunately, many institutions will adopt ESG without any real change in their investment process – just one more check box on their slide show.

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  2. I largely agree with what Bill says–for the short term. Eventually, ESG, with a strong emphasis on E (environmental/climate change), will have to take on much more institutional significance. As I see it, there are two main drivers: 1. Stark Reality: As the effects on businesses of climate change become more severe and widespread, the financial and reputational (which also affect the financial) risks will no longer be able to be ignored, 2. Demand: Climate change as fact-of-life is still not seen as a fact-of-life by much of the population at large. But, when you look into the numbers more deeply, you will see that a huge plurality of Millennials + your generation (Generation Jen? I like it!) see human caused climate change as a fact (80% of Americans under 35 in one poll I saw), a massive problem and something that needs to be dealt with seriously. These are the investors of the (not so distant) future. If y’all demand ESG be considered by the financial world, well, it will be considered by the financial world. So keep it up!

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    • Great points above. Stark reality and demand will likely be two contributors to eventual adoption of ESG. However – an extremely important aspect is client reward. It seems as though institutional clients have been offering limited reward to managers that are integrating ESG into the investment process – making those that aren’t skeptical of the benefits. Suppose all clients DEMANDED money managers only invest in ESG-friendly companies? There would be no debate. Fund managers would be forced to invest as such or they would lose all client assets and have no funds to invest with. Food for thought…

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  3. ESG awareness is a great start. I think that many investors, when faced with two like companies, would practice ESG-investing ~ especially over the long term. Luckily there are arguably more ESG compliant companies now than ever. Investment managers building these companies as options for their clients portfolios would be a great start, they may be amazed in the results.

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    • I think the problem is that the results have been mixed. There have been sustainable funds (solely investing in “highly sustainable companies”) that have fared well, and sustainable funds that have not. Mixed data does not make for a convincing argument…

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