Sustainable investing is an investment discipline that considers environmental, social and corporate governance (ESG) criteria to generate long-term competitive financial returns and positive societal impact. – The Forum for Sustainable and Responsible Investment.
Sustainable investing has undeniably captured the imagination – and dollars – of many investors. The U.S. total of sustainable investing strategies, which includes ESG factors, reached $17 trillion of professionally managed assets by the end of 2019, a 42% increase since 2018 according to the U.S. SIF Foundation (The Forum for Sustainable and Responsible Investment). They account for 33% of the $51.4 trillion in total U.S. assets under professional management. Pretty incredible.
I began analyzing this phenomenon several years ago, and it raised a number of questions. When did this start? Why is it attracting such attention? What is the expectation, and does it deliver? What challenges does it face? Here’s what I found out.
An Overnight Wonder?
Sustainable investing might seem like something new by media standards, but it’s been around for decades. Pax World launched the first sustainable investing mutual fund in 1971 – yes, 50 years ago! Clearly Pax was ahead of others via a mutual fund option, and its work preceded the development of Environmental, Social and Governance (ESG) factors as they are known today.
The developments in sustainable investing over the years have included the founding of The Forum for Sustainable and Responsible Investment (US SIF) in 1984 and a number of UN, global and national sustainable initiatives in subsequent years. The UN Principles for Responsible Investment launched in 2006 , and was a recognized step forward because it was the first time that ESG criteria (environmental, social and governance) were noted. Attracting particular interest in 2019 was the establishment of the S&P 500 ESG Index and the U.S. Business Roundtable’s Purpose of a Corporation statement signed by 181 business leaders of major U.S. companies, making a commitment to serve all stakeholders of a corporation.
There are, of course, other landmark activities along the way, but the above gives you an idea to how we got where we are today with sustainable investment offerings.
The Appeal? The Expectation?
People care about issues that are important to them and want to make an impact. By placing investments in line with their beliefs, they are provided an opportunity to influence behaviors beyond simply accumulating wealth. Investors are directing capital to companies that are reducing their environmental impact, or have fair labor practices, or are attentive to diversity issues, or adopt best practices in all matters of governance. Some investors seek to invest in companies that exhibit progress on some or all of these, while others are looking to exclude companies that are involved in activities they do not support. The options are abundant and accessible, with over 800 sustainable mutual fund and ETF offerings by the end of 2020.
Sustainable investing offers the opportunity to manage investment risks. Good corporate behavior on ESG factors is believed to mitigate many of the enterprise risks inherent in operations, such as reputational risk and legal risks surrounding controversies. When the CFA Institute surveyed their global membership in 2020 on why investment professionals take ESG issues into consideration in their investment analysis, they discovered that 85% of the 2,800 respondents considered E,S or G factors, citing the management of investment risks as their primary reason.
Many investors believe that values-based investing will not undermine their ability to reap competitive financial rewards. It is investing, not philanthropy, so the evaluation of corporate ESG factors should be added to traditional financial analysis in investment strategies. It should not replace traditional analysis. Many feel this combination improves long-term outcomes. After years of worrying about the short term, the quarter-to-quarter pressures that influence corporate behaviors, it is interesting to see an investing trend focusing on a long term vision for critical issues of our time.
One of the biggest challenges to sustainable investing is further developing its ecosystem. The unresolved items may sound tedious, but they are critical components of a credible ecosystem. Greater efforts must be placed on:
- Consistency of metrics,
- Comparability of various rating methodologies,
- Consistency of corporate disclosures, and
- Alignment of ESG factors with their relative materiality on any particular industry or business model.
If every option is not measured to the same standard, how can we objectively select the best alternative from what is available? Without these standards, confusion and skepticism will continue to undermine credibility.
Significant work is underway. The CFA Institute has undertaken creation of the highly anticipated proposal for investment product disclosure standards. Several standard setting bodies are communicating with one another about adopting common standards globally, and policy-makers and regulatory agencies here and abroad are adding to the effort. The SEC, for instance, has established an ESG task force and announced that it “has a role to play to bring consistency and comparability to ESG disclosure guidelines.” When completed, this will greatly impact the common tools for measuring success in this area.
Perhaps most importantly is how to demonstrate that financial returns on sustainable investing are competitive. There have been numerous studies suggesting that they are, but it is only the passage of time that will confirm the long-term results from numerous providers as competitive to other types of investing. So, yes, sustainable investing has been around for 50 years, but in some ways it’s still the new kid on the block.
Suzanne T. Mestayer is managing principal of ThirtyNorth Investments, where “Bringing Together Money and Meaning” is their mission.
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