Sustainable Investment May Not Be Mainstream - But It’s On Its Way

At a time when environmental, social, and governance (ESG) investing seems to be making major strides, skepticism about whether sustainable or socially responsible investing will soon be —or ever be—mainstream still persists.

One of those skeptics (or realists, as he might argue) is David Blitzer, managing director and the chairman of the index committee at S&P Dow Jones Indices. As he told Quartz recently, even though new stock indexes are being created, like the MSCI World ESG Leaders Index and the Equileap Global Gender Equality Index, which take ESG into account, ““I think it will take a long time before the official benchmark will get completely adjusted.”

It’s true that ESG investing isn’t about to replace traditional investing. Significant obstacles do remain, such as a lack of agreement about the best approach and an absence of international standards or rules governing sustainable investing.

No denying the momentum

But the momentum for ESG disclosure and investment has arguably never been higher. As TriplePundit reported last week, a major new responsible investing survey found resistance to ESG, particularly in the U.S., is falling away. One in four U.S. investors now say that an ESG integrated portfolio will outperform a non-ESG portfolio, five times the number who agreed in 2017.

Among the optimists are traditional firms such as State Street Global Advisors, BlackRock, Inc. and Putnam Investments. Chris McKnett, head ESG strategist at State Street Global Advisors, told InvestmentNews, “ESG is rooted in improving the investment outcome, rather than some other goal which may not be investment-oriented, and that's where we're seeing some convergence."

Make way for the millennial investor

While some of the old guard may be slowly changing their views on ESG investing, they may soon have to make way for the strong interest in ESG being shown by women investors, particularly millennials. Younger generations are driving the fast growth of the “green bond” market and the field of sustainable finance in general.

According to the Robb Report, estimates from the impact investing firm Swell Investing show that these women investors have the potential to add as much as $22 trillion to investments in conscious capitalism. That would greatly increase the existing pool of nearly $9 trillion.

The proof is in the numbers. Statistics show that investments that factor in ESG deliver profits and long-term liability. The MSCI KLD 400 Social Index, a capitalization-weighted index of 400 U.S. securities that provides exposure to companies with outstanding ESG, reports that its annualized returns (over a 20-year period ending January 31, 2018) were 5.46 percent, slightly better than the S&P 500’s 5.43 percent over the same period.

As Jessica Huang, director of sustainable investing at BlackRock in San Francisco, told Robb Report, “Eventually, it won’t be called sustainable investing. It will just be called investing, with ESG as a material driver of risk and returns.”

Not just for tree-huggers

Huang pointed out that the proliferation of data on how a company’s activities have an impact on ESG is making it easier for investors to continuously incorporate these factors into their overall assessments. That includes, for instance, the ability to evaluate a company’s entire carbon footprint by extending the emissions calculations to their supply chain and their products. The mounting data related to environmental and social impacts is being measured right alongside such traditional measures as cash flow and earnings on the balance sheet, exposing risks and opportunities.  

Savita Subramanian, head of U.S. equity and quantitative strategy at Bank of America Merrill Lynch, is another proponent who sees the ESG train picking up steam. As she told Robb Report, “It’s not just for tree-huggers….An investor who only held stocks with above-average ranks on both environmental and social scores would have avoided 15 of the 17 bankruptcies we have seen since 2008.”

Trends bear out optimism

A number of trends bear out the case for optimism that sustainable investing may enter the mainstream faster than expected. Good governance remains a systemically important trend, increasingly a goal for regulators and for fixed income and equity investors through active ownership. ESG considerations have driven new regulations in a growing list of countries, which is tangibly affecting credit fundamentals. Global supply chains pose growing risks if poorly managed, and investors may be quick to penalize companies for human rights issues, environmental impact and other ESG considerations.

And not least, the urgent need for action around climate change, underscored by the recent sobering UN report on climate change, is not only a wake-up call for CEOs but is driving sustainable investment portfolios and more disclosure of climate-related financial risks.

The ESG revolution may have been quietly taking place over the past decade, but now it’s making some real noise. Those financial institutions not yet compelled into action may soon be pushed into it.

In fact, earlier this year, the United Kingdom’s pension fund association encouraged its members to vote against the chair of a company if they feel the company is not doing enough to ensure its business model is compatible with efforts to limit global temperature increases.  

That kind of activism may be as much a driver of change in how companies disclose—and how investors account for—ESG as anything else.