Investment portfolios incorporating environmental, social and governance (ESG) sustainability metrics continue to increase market share in the U.S. As of December 2015 they accounted for over 20% of professionally managed assets, or $8.7 trillion. (1)
More individual and institutional investors are demanding intentional ESG portfolio diversification options and financial advisors and asset managers are responding to this demand with more product offerings. Investment funds incorporating ESG factors grew from 201 in 2005 to 1,002 as of December 2015, a 17% annual growth rate. (1)
Active owners are playing an important role in this growth process through proxy voting, shareholder resolutions and direct dialogue with companies regarding ESG issues. Institutional investors and other asset managers are employing active ownership strategies, often in partnership with investor advocacy organizations as diverse as the Interfaith Council on Corporate Responsibility (ICCR), As You Sow and Carbon Tracker.
From 2014 through the first half of 2016 these active owner collaborations represented $7.81trillion in assets under management. They focused on issues like corporate climate risk, political spending and executive compensation disclosure, as well as workforce diversity and private sector retirement plan fiduciary duties. (1)
Refuting ESG Investing Myths
Many advisors and investors continue to focus on the perceived limitations of ESG analysis. One of the most commonly asked questions is whether active ownership using ESG analysis increases expenses and limits opportunity. Not according to a recent study by Hermes Investment Management, Ltd., whose stewardship teams advise global pension funds on more than $300 billion in assets.
“Historically, if you looked at ESG products, there was this idea that if you invest in ESG it will cost you money,” explained Geir Lode, head of the global equities team in a Dec. 7 interview. “But as long as they don’t exclude too much of the universe, there’s an opportunity to add value.” (2)
And what about situations where active ownership collaborations expand beyond company shareholders to include other stakeholders, like the recent Dakota Access Pipeline (DAPL) dispute over anticipated environmental impact on land owned by the Standing Rock Sioux Tribe? “Energy Transfer Partners, a major pipeline operator, has lost hundreds of millions of dollars from delays in the completion of the Dakota Access Pipeline. And its standoff with the Standing Rock Sioux Tribe over a section running through tribal lands could mean an additional $80 million a month in losses.”(3)
In this kind of situation, do company executives and ESG rating systems have a responsibility to inform shareholders, including pooled asset managers like mutual or pension funds, about the potential for business disruption and increased costs that can affect shareholder value?
At the recent RI America conference in New York, Laura Nishikawa, Head of Fixed Income ESG Research at MSCI, Inc., said that “If ESG signals, ratings or rankings are used to displace a conversation that is happening today between investors and their managers, then they have not done their job. If these metrics and data can be the beginning of a conversation and not the end of a conversation, it has great potential to take us from a place that is subjective into something that is more actionable.”(2)
Whatever the current limitations of ESG analysis and rating systems, the trend toward greater use by investors is clear. Jon Hale, Head of Sustainability Research at Morningstar, Inc., says advisors are using Morningstar’s rating system to monitor existing, non-ESG portfolios. They want to know how the funds they are already using for clients fare on sustainability metrics.
Advisors should pay attention to the rapid growth of ESG and sustainability metrics. Speak to your clients regarding the potential benefits and limitations of incorporating them into the investment selection process.
- US SIF Report on Sustainable, Responsible and Impact Investing Trends 2016