In ‘simpler’ times, when company executives talked with investors they focused on just a few elements: the products or services they offered, their markets and competition, and the management team. Those elements allowed investors to judge the risks and rewards around an investable idea.
Today, investors are increasingly also interested in understanding companies’ approach to a host of ESG issues. Depending on the industry, questions can include sourcing policies and supply chain oversight, employment and diversity practices, understanding whether and how a company is minimizing its carbon footprint, and how climate change impacts its business.
Call it what you will – ESG, ethical investment or SRI – the expanded lens through which investors are looking at companies is no longer confined to a small segment of the capital markets. According to the Global Sustainable Investment Alliance, ESG factors explicitly incorporated into investment analysis and decision-making cover $22.9 tn of professionally managed assets – or 26 percent of the total globally – and have grown 25 percent since 2014. Europe leads the way with more than $12.04 tn in assets, up 12 percent from 2014. In the US, $8.7 tn in assets, or nearly 22 percent of the total, fall under an ESG umbrella, up 33 percent in two years. And the US market could grow even faster: last year, the Department of Labor lifted restrictions prohibiting retirement plans from considering ESG factors.
The Trump administration’s policy reversals on climate change have not slowed investors’ interest in ESG, according to Lisa Woll, CEO of the US Sustainable Investment Forum. ‘We’re going to see even more of what we’ve seen for the last decade,’ she argues. Without any ‘national framework’ addressing these issues, Woll predicts increases by the private sector on ‘green-focused investing, clean energy and clean technology addressing climate.’
Barron’s recently published its second annual ranking of the top sustainable mutual funds, using Morningstar Research’s database of more than 35,000 funds that have been screened using more than 100 ESG criteria applied to each individual company in the funds’ portfolio, as calculated for Morningstar by Sustainalytics. Barron’s identified 203 large-cap actively managed funds with assets exceeding $300 mn whose ESG scores ranked above the S&P 500 index. It found 37 percent of those funds outperformed the S&P 500 over the previous 12 months, compared with 28 percent of all funds in the large-cap category.
But there’s more. Only 17 of the 203 funds describe themselves as applying ESG principles to investing. The overwhelming majority received high ESG scores as a byproduct of their investment process so some part of investment managers’ risk analysis seems to be screening informally for ESG principles, making the impact of ESG criteria on investment decision-making arguably much larger. Why is this?
Pointing to Equifax, Valeant and Volkswagen scoring low across a variety of ESG criteria, Barron’s argues that ESG-alert investors would have steered clear of all three before their highly publicized missteps and stock plunges. Major institutional players such as Morgan Stanley, Blackrock, Fidelity and JPMorgan all also offer ESG products and have acquired research capabilities or boutique ESG managers. The inevitable conclusion is that ESG investing represents a large and fast growing mainstream discipline within the broader investment community.
IROs occupy a unique place within their companies, facing outward to the financial markets while reflecting back into senior managements and boards those concerns on the minds of investors. That conversation is broadening to incorporate ESG issues.
Brad Allen is a former IRO and served as NIRI national board chair from 1996 to 1997.
This article originally appeared in the winter 2017 issue of IR Magazine.
