Momentum is building in socially responsible investment (SRI). A growing number of investment managers and their clients are now interested in investments that take into account environmental, social, and governance (ESG) issues. A decade ago, investing in a company was about making money first, ESG issues were secondary. In 2002, SRI was seen as a niche, “it was basically retail funds and ethical investors. Today, almost every large asset owner and asset manager is taking this very seriously”, said David Harris, head of sustainable business at London Stock Exchange Group.
Many investors want to reduce their environmental and social impact. They ask companies they invest in to create profits for their shareholders while improving people’s lives and protecting the environment. Profit versus sustainability is no longer a trade-off, said William Oak, a fund manager based in Frankfurt, “I want to meet my client’s expectations without compromising their children’s future and it’s time for the European policy-makers to seriously help me by actively promoting SRI”, he added. In fact, there is not a clear European SRI framework. Therefore, different interpretations of the concept can be made, but the common understanding is a long-term oriented investment approach, which integrates ESG criteria in the research, analysis and selection process of securities within an investment portfolio. Multiple strategies are used by SRI funds including thematic investment, engagement and voting on sustainability topics, impact investing, integration of ESG factors, negative, positive and norms-based screening. In the wake of the 2015 Paris Agreement (COP21), solidified at the COP22 in Marrakech in 2016, climate change is the most discussed ESG challenge. Other issues include nuclear energy, sustainability, diversity, human rights, consumer protection, animal welfare, management structures, work conditions, and executive remuneration.
According to the Global Sustainable Investment Alliance in early 2014, there were $18.3 trillion of assets managed following SRI strategies. In early 2016, it was $22.89 trillion. This 25% increase in demand comes from the whole spectrum of the industry, but millennials and women are the fastest growing segments of the investing public and are seeking responsible investments. Millennials, who are currently between 18 and 34, will represent a third of U.S. adults by 2020, continuing to fuel investment based on social and environmental ideals. U.S. SRI, which went from $639 billion in 1995 to $8.72 trillion in 2016, represent 22% of all investment assets under management in the U.S. and could hit new record highs in the near future. However, concern over climate change seems to be more important for European fund managers than for their American counterparts. The California State Teachers’ Retirement System revealed that only 13% of their U.S. managers integrate climate change with their investment decisions, in contrast to 61% of their European managers. In Europe, in early 2016, $12.04 trillion of assets were being managed under SRI strategies.
Contrary to conventional wisdom, socially responsible investments are not strictly the prerogative of institutional investors. It is relevant to the average retail investor who is saving for retirement and wants consideration of the long-term potential and risks. Although institutional investors still lead the market, the retail component of SRI went from 13.1% in 2014 to 25.7% in 2016. A report from 2015 by the Global Impact Investing Network found that 17 percent of SRI funds targeted retail investors in the United States. According to BNY Mellon, there are 91 million investors in the retail investing market, representing a significant market opportunity for SRI funds.
Just as investors’ profiles, the asset allocation distribution is also changing, registering a significant decrease in equities from 50% of the total SRI assets in 2015 to 30% in 2016. There was a sharp increase in bonds, in particular green bonds, from 40% in late 2013 to 64% in 2016. The green bonds market is expected to reach $150bn in 2017. China accounts for almost 40% of the $81bn of green bonds issued globally in 2016. The Climate Bonds Initiative reckons green bonds represent 2% of all bonds issued by Chinese domestic institutions and corporations in comparison with 0.2% globally. However, the lack of transparency on how the proceeds are used could revive concerns about Chinese banks struggling with bad loans, and more generally, about the Chinese corporate debt. Therefore, more information and data are needed about how the money raised through green bonds is used.
The difficult access to information, forward-looking data and reliability of data applies not only to Chinese green bonds. It is a well-known barrier to the integration of extra-financial criteria in an investment process, such as ESG factors. SRI funds need high-quality ESG data to accurately inform their decision-making and asset allocation process. Therefore, a lack of standardised reporting can be a challenge for SRI investment teams and SRI strategies growth. This is why it is crucial that companies, regulators and exchange operators support enhanced data disclosure. Providing high-quality ESG information is beneficial to companies themselves, according to London Stock Exchange Group, “ growing evidence shows that issuers who provide high-quality information on ESG, are more likely to attract and retain long-term investors”.
To meet the growing demand for data, benchmarks and set definitions, there has been a steady increase in SRI labels recently to bring transparency, mainly to retail investors. Moreover, index providers are developing more tools to help advisers and their clients choose responsible investments. In 2014, Bloomberg had gathered and reported ESG data to 17,000 ESG data service subscribers on 11,000 companies in 65 countries. In January 2016, the Morningstar Sustainability rating was launched. Two months later MSCI unveiled its MSCI ESG Fund Metrics to expand its ESG research into the mutual and exchange-traded fund spaces.
As ESG data can be more difficult to assess than financial performance, the main challenge is to understand how they impact companies and their valuations. For example, carbon impact may be measured by computing revenues per tonne of carbon emitted, and waste impact may be measured by calculating the ratio of revenues to tonnes of waste produced. ESG investment decisions are based on more metrics and therefore improved. BNP Paribas Investment Partners’ Jacky Prudhomme explained to Engaged Investor “having an in-depth knowledge of the ESG dimensions of a company will give you invaluable insight into that firm’s strengths and weaknesses. ESG is really about protecting you from reputational and operational risk, so you want to get some understanding of the risk inherent in the companies you’re investing in”.
Another hurdle is the belief that socially responsible investments will underperform. Fortunately, it has been proven that is a false assumption. In 2015 Morgan Stanley analysed, via its Institute of Sustainable Investing, data from 10,228 open-end mutual funds and 2,874 separately managed accounts over the previous seven years. The bank affirmed that socially responsible investments usually met, and often outperformed comparable traditional investments. Moreover, the MSCI KLD 400 Social Index, which is comprised of firms with high scores on ESG criteria, outperformed the S&P 500 by 45 basis points since 1990. Therefore, socially responsible investments are a profitable step for fund managers and a sustainable leap for humanity. What more could we ask for?