ESG Investing has Seen a Rapid Growth in Assets Over the Last Few Years
Environmental, Social, and Governance, or ESG, investing has seen a rapid growth in assets over the last few years. In 2018, over $12 trillion was invested in the United States under sustainable investing strategies incorporating ESG factors, a 38% increase since 2016. ESG investing is forecasted by many research organizations and asset managers to continue to skyrocket over the next decade, and many expect public pension plans to lead that charge.
The Forum for Sustainable and Responsible Investment (USSIF) estimated that in 2018, 54% of ESG-invested assets under management came from public pension plans. However, when we take a close look at our state public plans, any reference to ESG or sustainable investing seems largely absent in Investment Policy Statements (IPS) or lists of funds. A recent Callan Study corroborates this view, as it found a distinct regional difference in ESG adoption of institutional plans, with only 31% of respondents in the Central United States (including Texas) claiming they were factoring in ESG principles. Why so low? That same study highlighted the biggest reasons for not incorporating ESG principles as:
- My fund will not consider any factors that are not purely financial in our investment decision-making
- Lack of research tying ESG to outperformance
- Unclear value proposition
|Source: Callan Institute/Click image to enlarge chart.|
One of the biggest hurdles to the adoption of ESG investing is understanding the value proposition. From Sage’s perspective, the value of ESG investing is clear: investing in companies that are focused on sustainability issues will ultimately lead to long-term success. It not just a “values” proposition for doing good for various stakeholders, but also a “value” proposition that these companies will, over a long time horizon, be the ones still standing.
The term “ESG” was first widely coined due to efforts by the United Nations Global Compact in 2004, and their release of the report “Who Cares Wins.” So why should investors care? ESG analysis spotlights environmental, social, and governance issues that may not be captured in traditional financial analysis but are financially material to a company or industry. A lot of great work has been put in by many organizations, such as the Global Reporting Initiative (GRI), Principles of Responsible Investing (PRI), and the Sustainable Accounting Standards Board (SASB), to ensure that investors are focusing on the right issues for a given company and industry.
In SASB’s case, a dedication to making an impact in sustainable accounting has had profound impacts on ESG investing. Most notably, SASB’s Materiality Map is an excellent tool both for investors and companies to decipher the most important sustainability issues that a company faces, issues that impact the financial conditions or operating performance of a company that may not be reported in financial statements. And if these issues are proven to have financially material impacts on these companies, one would opine that if you are not factoring these issues into your investing decisions, you are missing a key piece of the puzzle. Multiple studies from well-respected leaders in financial services, such as ISS and Morningstar, support this notion, as they are starting to show that ESG-investing has demonstrated it can both outperform traditional investment strategies and limit volatility.
Another important factor to identify is that ESG analysis is not a static process, but rather a very dynamic, constantly changing activity that is meant to be agile in order to address emerging matters. This flexibility adds another dimension to ESG investing that can be valuable to investors.
As an example, data privacy breaches have existed for quite some, costing companies such as Equifax and Target reputational damage and shareholder value. But it was not until 2018, when a whistleblower revealed that Cambridge Analytica had collected data on millions of Facebook users to create fake personality profiles for the U.S. presidential election, that data privacy truly became a mainstream investing issue.
Before news of the scandal broke, the ESG-based analysis from companies such as Arabesque and Sustainalytics had negatively flagged Facebook due to extreme weaknesses in data privacy management. For its transgression, Facebook was fined $5 billion by the Federal Trade Commission and lost $24.5 billion in market value over the coming months.
As investors, wouldn’t it be valuable to identify potential problems in companies before they escalated? Wouldn’t it also be beneficial if investors were able to enact positive changes within a company, or at a minimum divest from holding these companies and mitigate potential risks?
Some public pension leaders are recognizing that their goals parallel those of a sustainable corporation.
Plan trustees have the responsibility for making sound decisions to not only ensure the needs of current plan participants are balanced with the impact of plans on current taxpayers, but also to ensure the needs and interests of future members and taxpayers are satisfied as well. Public pension plans are meant to run in perpetuity, so why are we not looking at the corporations that we invest in and that are a part of our communities in the same light? And just as public pensions are focusing on important matters, such as workplace diversity and employee well-being, why would they not also hold the companies in which they invest to those same standards?
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Anyone who was in Houston when the Enron Scandal was unfolding knows the real impacts of bad governance. Shareholders may have lost over $70 billion in assets, but more importantly, the 7,000 employees within the city limits lost their jobs and huge portions of their retirement savings, as many had sizeable holdings in company stock. In its prime, Enron was injecting a sizeable portion of its $100 billion annual revenue into the local economy, which saw operations quickly come to a halt almost overnight. Public pension plans across the country took a huge hit too, such as the Florida Retirement System, which lost over $300 million.
The views expressed herein do not constitute research, investment advice or trade recommendations, do not necessarily represent the views of Sage Advisory or TEXPERS, and are subject to revision over time.