As I prepared for a recent presentation, I pulled some data from a report my firm had published six months earlier on developments in environmental, social, and governance (ESG) investing, socially responsible investing (SRI), and impact investing.
What I found surprised me.
UN PRI Signatories and Their Assets under Management (AUM)
The above graph shows two data series: The blue line represents the asset managers that have signed on to the United Nations-supported Principles of Responsible Investing (UN PRI), and the green bars display the total assets under management (AUM) held by those firms. In 2006, roughly six firms with a combined $200 billion in AUM were signatories. Ten years later, 60 firms with a total of $14 trillion in global AUM were on board.
The chart below, taken from the same report, shows what portion of that $14 trillion is from the United States. Note the significant jump in 2014.
US Investment Funds Incorporating ESG Factors
The move from $1 trillion in 2012 to over $4 trillion just two years later surprised me — a 300% change as the number of funds grew from around 650 to roughly 800. The most recent data from 2016, which is not shown in the chart, indicates nearly $9 trillion in total assets.
The question that struck me when I saw all this: Did all of the asset managers that are now factoring ESG into their investment process shift all $4 trillion in assets the day they signed up with the PRI?
The answer, of course, is no. Nothing changed. Not really, anyway. While the move into ESG investing demonstrates greater consciousness on the part of investment managers, the factors themselves are “soft” in their application. As Christopher Scott Peck, Hal Brill, and Michael Kramer observed in The Resilient Investor:
“ . . . we recognize that the softer ESG ‘considerations’ approach, while a step in the right direction, is less socially and environmentally impactful than SRI’s traditionally more active approach of designing portfolios and mutual funds to screen out the worst actors and seek out companies charting beneficial new directions.”
The stampede of asset managers into ESG over the last four years is reminiscent of another time and another industry.
In the 1980s, the emergence of organic farming created an opportunity for food producers to differentiate themselves and their products. Overnight, many farmers started claiming their crops and livestock were “organic.” Not until nearly two decades later, when regulators caught up and standards were put into place, did the term “organic” start to carry real meaning for the consumer. After all, what does it mean if chickens are “free range”? How much “range” does a chicken need to be “free range”?
Like organic farming 30 years ago, ESG investing today has gray areas.
The problem for ESG asset owners and investors is how to first define their specific ESG objectives and then audit or enforce those objectives under their given mandate. Eliminating tobacco stocks from a portfolio is straightforward enough. Controlling the carbon footprint of a portfolio is a different matter altogether. Holding asset managers accountable to a given set of goals and standards is key.
Wherever you stand philosophically, as a practical matter, the ESG movement is here to stay. Those who believe in the double or triple bottom line don’t think there is a conflict between “doing well” and “doing good.” Rather, both objectives — acting socially responsible and supporting investor goals — are not mutually exclusive, but mutually reinforcing.
A large body of academic research conducted over the last 30 years backs this up. In “ESG and Financial Performance: Aggregated Evidence from more than 2000 Empirical Studies,” Gunnar Friede, Timo Busch, and Alexander Bassen conduct a meta-analysis of ESG studies since 1979 and conclude that 90% show statistical evidence of a relationship between ESG factors and positive financial results.
We are a long way from understanding what distinguishes one ESG manager from another and how we as a society measure the effect of a given ESG portfolio. It’s like trying to differentiate among organic farmers in 1987.
But investors, regulators, and standards will catch up.
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All posts are the opinion of the author. As such, they should not be construed as investment advice, nor do the opinions expressed necessarily reflect the views of CFA Institute or the author’s employer.
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