ESG investing (i.e. incorporating environmental, social and governance factors in investment decision making) seems to be everywhere. FTfm every week is guaranteed to have at least two pieces on it! Most asset managers will include an ESG option in their product range. Most investment conferences have an almost obligatory ESG session. There is largescale lobbying by government and non-government agencies to promote the subject.
People who can talk in big numbers tell me that ESG style investing is worth about $30 Trillion globally. And it’s growing rapidly.
The concept clearly has appeal – earning investment returns and “doing good”. What’s not to like?
Interest has broadened out from initially endowment and charity sectors to a wider general audience, including the much sought after millennials. This level of interest will expand even further into institutional pension plans as new European pension directives mean that trustees of pension schemes will at least have to consider ESG factors in their investment decisions (whether they actually allocate or not). Such discussion and consideration will need to be evidenced, noted in their statement of investment principles, and made publicly available.
One big question always looms. Does it negatively affect investment performance? Well every fund management group will probably tell you no; or that any effect is actually positive. But really, it’s probably too soon to see the full impact of ESG considerations on investment performance given the data to hand. It certainly hasn’t been through a proper investment cycle in its current scale. As assets grow in the sector it will also have a greater influence on share prices.
In terms of performance, much depends as well on what specific factors are included in any definition of ESG for investment purposes. What’s the policy on fossil fuels for example? Do we exclude everything or just the “nastier” end of the carbon spectrum? Going for full fossil fuel exclusion there will definitely be a relative performance impact, given the weighting of energy (and its volatility) in global benchmarks. There is a wide range of views around this specific point.
Don’t underestimate the task of moving into an ESG framework and be aware that it’s an evolving space. Fixed income, for example, is likely to see a wider range of options into the future as Blue bonds join Green bonds and other credit instruments come into the space.
Despite the seemingly frenetic pace of growth of interest and assets in ESG strategies, the increasing availability of investment options, and the appeal of the message, this is not something investors should rush headlong into.
There a number of key steps well worth considering.
mCanvass views. What do people want? Not everyone feels the same passion on these issues and there a wide range of product on offer from asset managers, from quite specific to a very broad church of ESG issues. While in the DC world it can be straight forward to offer an ESG choice. – it’s more complicated in the DB world and trustee responsibility as defined by deed is typically to deliver a purely financial return.
mResearch the asset manager thoroughly. There isn’t enough standardisation, transparency or consistency in how different entities score companies on ESG factors. This applies to both active and indexed offerings. Inconsistency can lead to surprise – for example some sustainability indices can include tobacco companies, which seems out of place.
mFully understand and quantify the performance impact of employing any ESG considerations. This will allow for informed review of the bottom line impact of the strategy and the potential, if necessary, to re-shape it. Investment managers need to understand the priority of ESG in the totality of what they deliver to clients and scale it accordingly.
If it’s worth doing – it’s worth doing well.
Tradewinds 