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Environmental, Social and Governance (ESG)

Environmental, Social and Governance (ESG) criteria is a framework for evaluating a company’s impact on the environment, community and employees, and for measuring the effectiveness of their corporate governance policies. Impact investing, Socially Responsible Investing (SRI) and sustainable investing are all terms that refer to investing based on ESG factors.

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Environmental, Social and Governance (ESG)

Environmental, Social and Governance (ESG)

Environmental, Social and Governance (ESG) criteria is a framework for evaluating a company’s impact on the environment, community and employees, and for measuring the effectiveness of their corporate governance policies. Impact investing, Socially Responsible Investing (SRI) and sustainable investing are all terms that refer to investing based on ESG factors.

Modern impact investing dates back to the 1960s, when hot-button issues like the Vietnam War, Civil Rights and women’s equality created a new generation of investors who wanted to put their money with companies that shared their values. Responsible investing hit the mainstream in the 1980s with anti-apartheid investment strategies and divestment protests at many universities. Today, impact investing covers a broad range of concerns, including carbon emissions, labor practices, human rights, corporate scandals, gun control and gender equality. [i]

Impact investing runs on a spectrum from incorporating ESG factors to influencing corporate behavior. At one end of the spectrum are investors who consider ESG criteria along with the usual fundamental criteria for evaluating stocks, whether due to values or to enhance performance. Sustainable investing explicitly includes ESG objectives by excluding companies or industries, targeting an ESG score for the portfolio or maximizing exposure to high-ESG rated companies. At the other end of the spectrum is investment stewardship, when investors engage with firms directly or through proxy voting to affect corporate policy.[ii]

ESG Goes Mainstream

Both the interest in ESG investing and assets under management have skyrocketed in the last several years. According to the SIF Foundation, approximately $8.7 trillion—or one-fifth—of all investment under professional management was invested in impact investing in 2016. This represents a 33 percent increase since 2014 and a doubling in assets since 2010.

Investor demand for ESG products is higher than you may expect. A 2016 survey by Morgan Stanley and Cerulli Associates found that about 70 percent of investors are interested in impact investing, with stronger interest from women and Millennials.[iii] Another study done by Schroders in 2016 found that 82 percent of investors would stay in an ESG investment longer than a traditional one. [iv]

Millennials are a demographic financial advisors cannot afford to ignore and are much more concerned with the environmental and social impact of their investments than older generations. They are the largest generation and, by 2020, one in three Americans will be a Millennial.[v] The oldest cohorts, born in the early 1980s, are just now entering their prime earning years and will be significant drivers of investment dollars for decades to come.

The Morgan Stanley survey showed 86 percent of Millennials are interested in impact investing and are twice as likely to invest in a stock that they consider socially responsible.[vi] Schroders found Millennials rank ESG factors as equally important as performance when making investment decisions.[vii] The opportunity is large and products are beginning to come online to provide impact investment solutions with low costs and low minimums.

How to Invest

There are now more than 500 mutual funds, variable annuity funds, ETFs and closed-end-funds that incorporate ESG factors, accounting for more than $1.7 trillion in assets.[viii] For a long time, mutual funds were the only game in town for retail investors. Socially responsible funds were mostly offered by a handful of specialized firms like Parnassus, Pax World and Calvert, and were concentrated in equities. The vehicles available to investors have risen exponentially in recent years. No longer a niche product, both fixed income and equity ESG mutual funds are now offered by many of the largest asset management firms.

The ETF industry is a relative newcomer to impact investing, but has done some serious catching up in the last couple of years. The first ESG ETF launched in 2005, but by 2015 there were still only seven ESG ETFs on the market. Most were focused on very narrow mandates, like workplace equality or low carbon emissions, and were difficult to work into asset allocation portfolios. This all changed in 2016 with the launch of 20 new ESG ETFs, including several style box equity funds and the first international equity ETF. With major asset managers like Oppenheimer, Columbia, Nuveen and Legg Mason making commitments to impact investing using ETFs, we anticipate significant growth ahead.

ESG Performance

It is a myth that impact investing is associated with a performance trade off. Recent studies have shown that there is little impact to performance, and considering certain ESG criteria may in fact improve returns. A Morgan Stanley study found that sustainable equity mutual funds met or exceeded performance of traditional equity mutual funds 64 percent of the time.[ix] The MSCI KLD 400 Social Index has outperformed the broader Russell 3000 Index by 0.22 percent annualized since its inception in 1990. At the individual stock level, companies with high ESG ratings have a lower cost of capital and disclosing ESG information to the public may result in lower volatility, according to research by Blackrock.[x]

The sustainability initiative is a focus for many investors these days, so knowing about ESG criteria and opportunities should be top-of-mind for financial advisors.

Sources:

  • [i] “Sustainable. Responsible. Investing for Impact”, SRI Conference, http://www.sriconference.com/about/what-is-sri/history-of-sri.html.
  • [ii] “Exploring ESG: A Practitioner’s Perspective”, Blackrock, June 2016, https://www.blackrock.com/corporate/en-us/literature/whitepaper/viewpoint-exploring-esg-a-practitioners-perspective-june-2016.pdf.
  • [iii] Hale, John, “The Appeal of Sustainable Investing”, Morningstar Magazine, Dec/Jan 2016, Pages 3-7, https://global.morningstar.com/Morningstarmagazine.
  • [iv] Moore, Rebecca, “Millennials Driving Interest in ESG Investments”, November 28, 2016, Plan Sponsor, http://www.plansponsor.com/Millennials-Driving-Interest-in-ESG-Investments/.
  • [v] “Are Millennials Democratizing Sustainable Investing?”, Morgan Stanley, March 6, 2017, https://www.morganstanley.com/ideas/millennial-sustainable-investing.
  • [vi] Hale.
  • [vii] Moore.
  • [viii] “Report on US Sustainable, Responsible and Impact Investing Trends”, The Forum for Sustainable and Responsible Investment, 2016, http://www.ussif.org/trends.
  • [ix] Morgan Stanley.
  • [x] Blackrock.

Disclosure: The opinions expressed in this document are those of the NinePoints Investment Management (NPIM) research department at the time of this writing and are subject to change at any time without notice. This document is provided for information purposes only. It does not constitute an offer or a recommendation to buy or sell securities or other financial instruments mentioned and it does not release the reader from exercising his or her own judgment. Every investment involves risk, especially with regard to fluctuations in risk and return. The investment mentioned in this document may not be suitable for all types of investors. Past performance does not guarantee future results.

See referenced disclosure (2), (3) and (4) at http://blog.americanportfolios.com/disclosures/ 

About The Author

Cliff Walsh, CFA

 

Vice President of Asset Management 
631.439.4600 ext. 277 

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