ESG investing is expanding—and adds to returns
Two new reports highlight the expanding adoption of Environmental, Social, and Governance (ESG) criteria among money managers, as well as the benefits to the bottom line that accrue to ESG-savvy investors.
The biennial Report on US Sustainable, Responsible and Impact Investing Trends from US SIF, the trade organization for the SRI industry, shows a continuation of the rapid adoption of ESG criteria among mainstream money managers that was noted in the previous Trends Report. In the last two years, the value of portfolios that include consideration of ESG factors has mushroomed by 69%, to over 8 trillion dollars, under the management of 777 money managers and institutional investors, and over 1000 community investing financial institutions. While the number of more active money managers who filed shareholder resolutions did not rise appreciably (225 this year), it appears that some larger players are joining in this crucial element of SRI, as their portfolios total over 2.5 trillion dollars, a nearly 50% increase since 2014. Check out these three infographics to get a quick overview of the ESG landscape; you’ll find some useful context about the relative shares of community investing, corporate investment, and public funds investment.
Meanwhile, a new analysis by Barclays affirms the now long-standing conclusion that ESG consideration tends to increase the performance of bond portfolios. Attending to Governance factors, in particular, seems to be a powerful indicator of better financial performance:
The gains (measured here by two different techniques) are modest but enduring: a 0.29% to 0.42% premium per year over the past seven years. It should be noted that Barclays distinguishes between SRI’s traditional negative screening (e.g., no coal companies) and a best-of-class approach (e.g., rating coal companies and choosing only the more responsible ones), noting that the softer ESG “considerations” approach is more apt to lead to the increased returns. It’s also interesting to see that while Environmental factors are most important to 57% of the the asset owners, Governance is the primary factor for nearly 80% of asset managers.
The numbers from the US SIF report, which look beyond bonds to entire portfolios, are more promising. Among institutional investors, the leading ESG criteria are restrictions on investing in companies doing business in regions with conflict risk (particularly in countries with repressive regimes or sponsoring terrorism) and consideration of climate change and carbon emissions. The total funds under management in the United States that consider ESG factors in making investment decisions now totals nearly 9 trillion dollars, amounting to one in five dollars under professional management.
We find these trends encouraging! At the same time, we recognize that the softer ESG “considerations” approach, while a step in the right direction, is less socially and environmentally impactful than SRI’s traditionally more active approach of designing portfolios and mutual funds to screen out the worst actors and seek out companies charting beneficial new directions. Considering ESG factors does not preclude investments in companies with poor records (just as completing a sustainability audit does not necessarily mean your business is truly sustainable). Thus this is a weaker standard than SRI’s historic positive- and negative-screening approach. Of course, we must also admit that most SRI mutual funds also make judgement calls about key issues, such as workers’ rights, environmental sustainability, and health (many giant brands that have no particular social-environmental value are top holdings in SRI mutual funds—e.g., Microsoft, GE, Wells-Fargo, Home Depot, Walt Disney). Other than funds that screen out particular industries such as munitions, tobacco, or coal, there has always been a large grey area in SRI; the new ESG-considerations approach takes us deeper into the grey. (For more on this cautionary angle, see this article from NI’s Andy Loving, published in Green Money Journal after the 2014 Trends Report came out).