The arena of socially-focused investing has never been more in demand than today. From individual investors to massive pension plans and every size nonprofit institution in between, environmental, social and governance (ESG) concerns are widespread and growing. Historically, focusing on these areas was primarily the domain of religious institutions seeking to avoid exposure to specific industries or stocks in accordance with their religious beliefs and tenets. Today, ESG investing holds more than $1 of every $6 in U.S. assets under management, growth of over 76% since 2012 alone. How has this framework evolved? What are some current trends in the movement? Are there still issues to resolve?
Investors utilize a variety of methods to implement a socially-aware investment approach. Broadly, ESG Incorporation and Shareholder Advocacy are the two primary strategies.
1. ESG Incorporation – the active review of various ESG factors in the portfolio construction process. An investor traditionally focuses on one or more areas of importance to their mission (e.g. avoidance of tobacco) and investment decisions are built around this position. Importantly, portfolio construction can utilize both positive and negative screening, that is, either seeking out companies promoting “good” in a particular industry or actively excluding companies violating specific ESG criteria. Community investment represents an additional subset of ESG incorporation. Among the fastest growing areas of social investing, community investment seeks to direct capital to poor or underserved areas where traditional financial service institutions are not as prevalent or accessible. Those making community investments often accept below market returns for a greater social purpose.
2. Shareholder Advocacy – intentionally owning shares of companies in order to influence corporate strategy around ESG concerns. Proxy voting and shareholder engagement remain the two more common methods, and many of the world’s largest publicly traded companies are frequent targets of such campaigns. Practically, many investors lack the size and scale to alone influence change at such large institutions, thereby these efforts center on awareness and more recently, “crowdfunding” and other social platform communications.
Areas of current focus in the ESG arena include both product and process. From 2012 to 2014, the number of ESG-focused mutual funds in the United States grew from 333 to 456, with assets in these funds increasing from $641 billion to $1.93 trillion1. Demand for ESG aware investments is also emerging within alternative investments, including products in social venture, private equity and even hedge funds. Many asset managers, both traditional and alternative, have begun incorporating ESG frameworks into their security selection process. Under this scenario, a portfolio manager may insist on strong corporate governance from a potential holding candidate (the “G” in ESG) or as a broader investment theme, such as favoring those companies involved with renewable energy sources.
While traditional areas of ESG focus (e.g. tobacco, gambling, firearms) remain under close watch by many religious institutions, other categories—environment, workforce diversity, women’s rights and compensation and other non-discriminatory campaigns—are receiving strong interest. Within environmental concerns alone, there are a multitude of timely topics, including global warming, deforestation, water conservation, fracking and green energy. The intersection of environmental focus and investments remains headline news for the Catholic Church. In May, Pope Francis published an encyclical calling for a phase-out of fossil fuels, prompting many Catholic institutions to investigate divesting of coal and other fossil fuel-exposed stocks2. In a follow-up statement revealing the complex nature of ESG investing, a Catholic church official recently advised that the Vatican may consider, but is not committed to, divesting its holdings in fossil fuels3.
Millennials, roughly defined as those under the age of 35, are a significant area of focus in today’s ESG discussions. According to several recent studies, Millennials are closely linked with the ESG movement; in one study, 76% of those under age 35 were “interested” or “very interested” in SRI investments4. Consider also that Millennials embrace technology and social networking tools and studies illustrate this age group appears willing to accept higher risk or receive lower return in order to invest in companies with strong ESG profiles. Consequently, these same individuals are more likely to consult ESG factors when considering employment and charitable giving. As all nonprofits aim to hire and retain talented individuals and compete for charitable giving, awareness of ESG considerations extends far beyond social wellness and can make good business sense as well.
While the ESG movement continues to grow and evolve, meaningful challenges do exist. From a lack of clarity with the nomenclature to concerns about limiting diversification through constraints and the still limited universe of ESG investments, these hurdles pose a threat to continued growth. Numerous studies have attempted to quantify if an ESG approach increases or limits returns relative to the broad market. To date, there doesn’t appear to be a preponderance of data one way or the other; perhaps the most relevant concern to most investors today is the relatively small universe of ESG investments and the limitations of ESG investing within alternatives5. As with any customized account, size and scale are generally required, thus further limiting a smaller investor’s ability to highlight specific ESG criteria from which to build a portfolio.
Overall, social investing has experienced enormous strides in its long history, evolving from primarily religious institutions focused on negative avoidance to a core consideration used by many investment managers in security selection and Investment Committees in asset allocation. ESG investing has mirrored the times, becoming more commonplace just as the Millennial generation voices these concerns at the workplace and influences charitable giving. ESG investment remains a critical overlay for many religious institutions but appears poised to grow among many other investors in the years to come.
For more information, please contact any of the investment consultants at DiMeo Schneider & Associates, L.L.C.
