The Rise of ESG

Zach Schlaht / Sep 12, 2018 / Investments

Increasingly, investors want to put their money where their values are.

The Rise of ESG

Environmental, Social and Governance, or ESG, has slowly morphed into a catchall for what has historically been known as socially-responsible investing (SRI). While SRI focuses on mostly negative screens such as screening out companies involved in tobacco or gambling, ESG takes it a step further by applying an analytical framework to a business’s underlying fundamentals aimed at positive things companies are doing that may help their business perform better.

Examples of ESG factors span many different issues ranging from climate change, to workers compensation and social equality, among others.

 

ESG analysis was first utilized by pension funds for trade workers in the nineteen-fifties as a way to support worker rights and other social causes.

More recently, ESG-based investing has been supported by the United Nations via its “Principles for Responsible Investing” guidelines, which has attracted over $80 trillion dollars for responsible investments. 

ESG AUM signatories graphSource: Principles for Responsible Investment (PRI)

Over time, and with the availability of robust data, ESG has turned into a set of analytical tools that uncovers poor or unethical business practices while highlighting positive actions undertaken by businesses. This has helped investors align their portfolios with their underlying values in what is now known as values-based investing.

ESG-driven mutual funds and exchange-traded funds (ETFs) have been known to exert influence in a number of ways, contingent on what the fund hopes to accomplish. For instance, not only is the investor voting with their dollars to support a company with positive ESG factors, they are also offering fund managers the right to use their shareholder votes to enact change on behalf of the shareholders themselves. This has intrigued investors as both a direct and indirect way for bringing about change. Large asset managers like Blackrock and Vanguard are coming to terms with their significant voting power due to the large amount of shares they hold in their index funds. Utilizing this, while rolling out additional ESG focused funds, has enabled the asset managing giants to directly, and positively, impact businesses and produce change.

The demand for ESG has exploded in recent years as investment management firms and corporations begin to see the impact that specific environmental, social and governance factors have on their fundamental business and attractiveness to investors. According to a survey conducted by Oppenheimer Funds and Campden Research, 84% of ultra-high-net worth millennials and 36% of baby boomers are reported to show an interest in ESG, coloring it as a way to express their social, political and environmental values. This shift towards values-based investing has garnered the attention of fund companies and corporations and prompted competition across the investment landscape.

For the first time since ESG-based investing has started, it is possible to cheaply and effectively implement a global ESG portfolio. Expenses can heavily weigh on fund performance, which has hindered investors’ willingness to invest in ESG funds. However, thanks to increasing competition amongst asset managers, expense ratios have begun to nosedive, while the horizon of available asset classes has broadened.

One of the largest contributing factors to the recent increase in ESG popularity is the abundance of data. Data on businesses and their operations has become exponentially cheaper, more transparent, and easier to aggregate and analyze due to advances in technology and reporting standards. Companies such as Sustainalytics and index provider MSCI Inc. have pushed to incorporate ESG into indexes and provide data to fund managers, helping create many new investment products, such as mutual funds and ETFs. This is a far cry from how investors used to have to invest in impactful ways, namely expensive mutual funds and Separately Managed Accounts (SMAs) that require large minimum investments. The plethora of new index funds has enabled investors to be more nimble with their portfolios.

The availability of data has also pushed large companies to consider their governance practices, and to make public the changes they are implementing internally. Between 2012 and 2016, the number of companies in the S&P 500 consistently producing sustainability reports has increased from 20% to 82%. Much of this can be attributed to the fact that positive ESG factors can be seen as risk mitigating and return enhancing.

According to research by Harvard and Calvert Investments, analysis of ESG data can help mitigate risk while adding value to shareholders. Companies with higher levels of sustainability tend to be more attractive for long term investment; this indicates stronger business fundamentals that are focused on the long term.

Returns as well as overall expenses have historically been a deterrent for those looking to invest in ESG funds. However, more recently we have seen returns competitive with those of traditional funds. A main focus of Mosaic’s investment philosophy, keeping expenses down while focusing on total returns, has been a primary driver for our investment decisions. As the ESG landscape changes and becomes more attractive, we have been able to expand upon our clients’ interest in ESG to include more asset classes and to better mirror our global portfolio approach.

Banks and fund companies have begun to realize the significant value that ESG carries for individuals looking to make a difference with their dollars. Across generations there is a push for values-based investing and a general rise in the popularity of ESG funds. This demand for ESG investing has caused competition among fund providers to pick up, prompting prices to fall, performance to skyrocket, and business quality to sharpen.

We have been keeping a keen eye on the investment landscape and have broadened our investment horizon on behalf of our clients. ESG continues to be an issue we look to in order to expand our investment offerings, and focus on our clients’ values.

If you're searching for the right financial advisor, ESG involvement might be an important factor for you to consider. We also have an interactive workbook that can help you as you interview potential advisors and search for the right fit:

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Topics: Investments