Investors are increasingly aware of the social and environmental impacts of their invested dollars. As a result, the popularity of responsible investment strategies has grown substantially in recent years, leading to the development of new investment strategies, such as:
- Sustainable investing
- Socially responsible investing
- Impact investing
- Environmental, social, and governance (ESG) investing
As an investor, if you’re concerned about the effects of your invested dollars, it’s important to know your options and make sure your investments correspond with the issues that are important to you. A recent study of over 1,000 investors by Allianz Global Investors showed that while the vast majority of participants had never heard of ESG, 90% cared about at least one of the underlying issues and 80% acted on these issues in their day-to-day lives. That said, only 20% considered these issues when making investment decisions.
Let’s take a look at the history of—and approaches to—responsible investing strategies, particularly ESG, and how these investment approaches could benefit you and your business.
The Evolution of Responsible Investing
The modern origins of responsible investing began in the 1960s and subsequent decades, when issues such as civil rights, gender equality, anti-nuclear sentiment, and anti-apartheid sentiment escalated the desire for accountable and conscientious investing. Environment and sustainable-focused funds followed soon after.
By 2005, growing interest in responsible investing caused the United Nations to join with large institutional investors to outline the Principles for Responsible Investment (PRI). These were launched on the New York Stock Exchange in April 2006, and there are currently over 1800 institutional money managers following the principles. The PRI works with these signatories to share resources and jointly encourage companies to improve their practices.
In 2012, clearly defined ESG ratings that used the FTSE4Good methodology—a benchmark that measures the performance of companies with strong ESG practices—were launched. These ratings made it easier for investors to rate companies and established a standard for measuring the performance of ESG mutual funds.
Over the past five years, interest in ESG investing has grown rapidly. Assets in ESG-dedicated mutual funds and exchange trade funds (ETFs) in Europe and the US grew 50% from 2013–2017, according to Cerulli Associates. And, according to Morningstar, ESG fund assets under management increased from $95 billion to $118 billion between late 2016 and early 2018.
Responsible Investing Strategies
There are several terms often used interchangeably when referring to investing with a cause in mind. However, each strategy typically has different goals and methods. Here’s a look at the different investing practices and how ESG incorporates elements of each.
Sustainable investing typically focuses on an investment’s impacts on the environment. In a portfolio, it involves underweighting or excluding companies with poor environmental considerations or overweighting companies with positive environmental practices.
For example, a sustainable mutual fund manager may select companies that use environment-friendly product designs or exclude companies that emit harmful toxins and pollutants as part of their manufacturing processes.
Socially Responsible Investing
Socially responsible investing generally screens out companies that are associated with undesirable social practices, such as child labor, or entire product categories, such as gambling, tobacco, alcohol, and certain pharmaceuticals.
The primary focus of impact investing is to make a positive social or environmental impact alongside a financial return. Investments into impact-oriented institutions or funds provide capital to address a multitude of challenges, such as sustainable agriculture, renewable energy, and affordable and accessible healthcare, housing, and education.
ESG investing incorporates elements of sustainable, socially responsible, and impact investing and is a method for evaluating how a company’s environmental, social, and governance practices may impact its stock return potential.
- Environmental considerations include carbon emissions, waste, natural resource efficiency, renewable energy usage, and climate change initiatives.
- Social factors can be elements such as workplace diversity, human capital and supply chain management, product integrity and safety, and community impact.
- Governance generally incorporates board and executive diversity, corporate structure, accounting practices, transparency, and executive compensation.
A Note on Ratings
Approaches to ESG investing typically involve scoring companies based on the above environmental, social, and governance categories. Some ESG investments use negative screens that exclude or underweight companies that don’t score well, while others use positive screens to weight high-scoring companies more heavily. Still others will completely exclude certain parts of the market—such as weapons or tobacco.
Investors should do their research if there are specific products or practices they want to avoid. However, it’s important to remember that there’s no such thing as a perfect company. For that reason, many institutional ESG investors also use their power as shareholders to engage in direct dialogue, proxy voting, and shareholder proposals. This encourages companies to follow environmental, social, and governance guidelines and continuously improve their practices in these areas.
ESG Data Trends
Investors have varying reasons for using ESG criteria to evaluate their portfolios. Most share a sense of responsibility to use the power of their dollars to improve business practices. Many believe that companies focused on remaining sustainable in the future will do well over the long haul.
That said, research on whether incorporating ESG factors into investment decisions enhances or detracts from returns is inconclusive to date. The FTSE4Good Developed Index Series returned 10.7% annually for the five-year period ending August 2018, whereas the standard FTSE Developed Index returned 10.8% annually for the same period, according to FTSE Russell.
The BlackRock Investment Institute, using data from MSCI, determined that traditional funds and ESG benchmarks returned the same 15.8% annually between May 2012 and February 2018. During the same time period outside of the United States, the traditional developed international equity benchmark returned 10.5% and the returns for the ESG benchmark were at 11.1%. The difference was even greater for emerging markets; traditional benchmarks returned 7.8% for the time period and ESG benchmarks returned 9.1%.
We’re Here to Help
It remains to be seen whether ESG performance trends will continue. It does stand to reason that companies that score highly in ESG measures may be more efficient in resource usage and more resilient to ethical lapses and climate risk.
Either way, if you are concerned with the impact your invested dollars have, it’s important to know your options and make sure your investments align with the issues that are important to you.
To learn more about ESG investing, contact your Moss Adams advisor.