Both retail and institutional investor demand for ESG investing options is increasing. Research conducted by Natixis Investment Managers shows that 7 in 10 investors want to invest in companies that have a positive social impact and good environmental record.1 What’s more, 61% of retirement plan participants say they would increase plan contributions if they knew their investments were doing social good. Two-thirds of those who choose not to enroll in their company’s retirement plan said they would be more likely to participate if they knew their assets delivered societal benefits.2
In addition, more than half of the investors we surveyed believe that companies with higher levels of integrity will perform better than their peers.3 They want their investments to align with their personal values and contribute to a better world, but not at the cost of lower investment returns.
Although investors express a preference for ESG investing, it is usually only when faced with a choice between non-ESG strategies and strategies focused on sustainability. Many investors do not know ESG investment strategies are available to them. As a result, ESG strategies have not yet been widely implemented in client portfolios.
As financial professionals, we can help bridge this gap. It starts with having the conversation. While ESG investing is not a new way of investing, it is a new way of viewing investments for many investors and financial professionals alike. The terminology, varying approaches and misconceptions unique to the ESG landscape can make it a challenging space to navigate. These complexities can make it difficult to have meaningful conversations on the topic with clients who may be interested in learning more.
Investor motivations: Why ESG?
There are many reasons investors consider ESG investing. Therefore, different conversations and approaches may be necessary. At Natixis, we believe a client-focused approach to implementing ESG in portfolios can be more beneficial than a product-focused approach. Establishing a client’s investment preferences, values, and risk tolerance can make it easier to determine which ESG path may be best suited to their financial goals.
Generally, there are three main investor motivations for implementing ESG. One is values-based, aiming to align investments with an ethical or moral worldview. Screening approaches may be appropriate in this case. A second motivator is potential risk/return enhancement. Here, strategies that integrate ESG factors in investment analysis to better understand an investment’s risk/return potential may be relevant. The third motivator is positive environmental or social impact – contributing to a better, more sustainable world. It is important to note that for many investors, these motivators are not mutually exclusive.
Beyond investment case and values-based reasons, financial professionals can consider implementing ESG approaches as a value-add in their practice. Many financial professionals today are focusing on ESG as a way to differentiate their practice in an ever-evolving competitive landscape. As client demographics shift, ESG approaches may become more important in this respect.
Moving Beyond Myth
Financial professionals who are looking to provide ESG approaches to clients need to know what to ask for, what they are getting as a potential solution, and how that solution can align with client goals. Below, we identify, clarify, and challenge what we believe to be many of the biggest misconceptions about ESG and sustainable investing so that conversations with clients can be more comfortable and productive.
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MYTH: ESG investing is just a fad.
The US Forum for Sustainable and Responsible Investment (USSIF) estimates the size of the US sustainable, responsible and impact investing market is already nearly $12 trillion as of 2018 – one-fourth of all professionally managed assets in the US.4 While we take this number with a grain of salt given it is based on self-reporting by money managers, we do believe that the data is directionally accurate. Those money managers surveyed by USSIF cite client demand, risk management, and alpha potential as the top reasons for incorporating ESG in their decision-making processes.
While ESG might feel nascent in some areas of the world, there are examples in the US, Europe, Asia, and elsewhere that point to its importance going forward. For example, nations across the globe are establishing frameworks for sustainable finance. Major financial organizations such as the London Stock Exchange are focusing on sustainable finance offerings, and large institutional asset owners and asset managers are forming sustainability-focused coalitions, bringing together trillions of dollars to engage with companies, industries, and policymakers on these topics. For example, Climate Action 100+ is an investor initiative engaging the world’s largest corporate greenhouse gas emitters to encourage them to take action on climate change. To date, more than 370 investors with more than $35 trillion in assets under management have signed on to the initiative. We believe that ESG may become more the norm in investing as sustainable finance infrastructure improves, market penetration of ESG-focused products increases, and traditional asset managers integrate ESG factors across a larger portion of their assets.
MYTH: Sustainable investing is just a public relations and marketing ploy used by asset managers.
While we believe that an authentic change of mindset is occurring industry-wide, understanding a manager’s history of implementing ESG – their approach, research quality, resources, and investment philosophy – is very important. You can’t rely on labeling or marketing positioning alone.
For example, not all asset managers that incorporate ESG have a goal of creating positive environmental or social change. Some only use a handful of ESG factors in their fundamental analysis, or only exclude certain stocks such as those of tobacco companies.
MYTH: My clients and prospective clients don’t care about ESG.
There is plenty of evidence showing that investors are interested in sustainable investing – and it’s not just Millennials. According to our research, 75% of US workers believe it is important to make the world a better place while growing their personal assets.5
Despite the fact that ESG is a trending topic in the financial industry today and that we are witnessing an increasing preference for these strategies, we believe many investors are not aware that ESG investing strategies exist, let alone are available to them. This can hold true even in demographics where a higher level of awareness might be expected, such as among women and Millennials. Many clients may not be convinced of the potential benefits of sustainable investing until they understand the implications for their portfolio. Follow-up conversations and information on ESG investment opportunities – including potential performance and risk implications – remain imperative.
MYTH: ESG assessment doesn’t add value in the investment process.
As politics and demographics evolve in meaningful ways worldwide, the market may be underestimating long-term environmental, social and technological innovation potential and underappreciating ESG risks. We believe that taking a long-term view of businesses and integrating ESG into investment decision-making may lead to better long-term investment results. There have been many academic and industry studies that suggest that ESG quality is correlated with financial outcomes.
For example, a 2019 MSCI study6 demonstrated how ESG quality can impact stock performance, risk, and valuation. It showed that companies with stronger ESG profiles typically exhibit higher profitability, lower frequency of severe drawdowns, and lower systematic risk. The study’s results also exhibited the limitation of traditional valuation models that don’t appropriately account for all the risks that companies face today.
MYTH: ESG investing strategies perform poorly.
Perhaps one of the most pervasive myths about ESG strategies is that investors can either invest sustainably, or seek competitive returns over time, but not both. Historically, socially responsible investment strategies were focused on excluding “sin stocks” and other controversial businesses but stopped there. As a result, this exclusionary approach may have underperformed the broader market. Moreover, other factors play a role in performance outcomes, such as manager skill. However, many managers today view ESG and sustainability as pathways to idea generation and risk management that have the potential to result in better financial outcomes for their clients.
While it only measures one approach to ESG (best-in-class),7 we can compare the cumulative and risk-adjusted performance of the MSCI World ESG Leaders8 global stock index to that of its traditional counterpart.9 The results show that the ESG-focused index has performed in line with the traditional index by both measures.
MYTH: ESG strategies might compromise my fiduciary duty.
Natixis Investment Managers fully supports the Department of Labor’s latest guidance to ERISA fiduciaries on ESG and including ESG-themed options in retirement plans. In the process of evaluating what is in the best interest of the investor, we believe it is important for financial professionals to consider ESG factors along with all other material factors that may impact an investment’s risk/return potential.
We consider ESG assessment as one of the many ways to properly value securities and to identify sustainable businesses that have strong management teams and can create long-term value for shareholders. In retirement plans, ESG-themed options may sit alongside traditional options in the same asset class or style box and, if appropriate, can replace those traditional options.
MYTH: There’s no place in my portfolio for ESG-focused investments.
Because ESG investing is not an asset class or a separate style of investing, financial professionals do not necessarily need to carve out a separate portion of the portfolio for ESG strategies. They may be considered a core part of a portfolio, or a satellite component, depending on what makes sense given the particular client and the particular ESG product option.
When considering large-cap equities or municipal bonds, for example, you wouldn’t consider only the labels of available strategies. We believe the same should be true of ESG investing. Instead of focusing on the ESG label, look at how the manager implements the strategy, the strategy’s motivations, the level of ESG integration and the strategy’s characteristics and performance. Do the same due diligence you would for any other potential portfolio component. An ESG-focused international equity fund may be used in a portfolio in the same way a traditional international equity fund would be, while providing the added benefit of sustainability mindfulness.
MYTH: It’s difficult to scale my ESG-focused business because it’s too hard to find the right ESG product for each client.
We understand that individual clients may express very specific or seemingly restrictive environmental or social criteria – one may be solely focused on gender equality issues while another may have zero tolerance for fossil fuel exposure. However, there are many approaches today that can address a diverse range of desired outcomes, from faith-based investment criteria to promoting investment in renewable energy. It may require a deeper conversation about the approaches used and how they ultimately align with specific criteria. Asset managers like Natixis are here to help in these discussions. Additionally, for clients more interested in individual exclusions, there are customized ESG screening options available via separately managed accounts and direct indexing strategies.
MYTH: ESG is all about excluding sin stocks.
While excluding tobacco, alcohol, and contraceptives may be a preferable investment approach for a religious institution, it may not work for everyone. There are many different ESG approaches available to investors today. Rather than focusing on exclusion alone, many implement a more affirmative approach to security selection – seeking to invest in companies with stronger overall ESG profiles and companies whose missions are directly connected to long-term sustainable development trends. ESG analysis can also be used to better understand potential investment risks and opportunities. For example, the ways in which a given company considers issues such as energy efficiency, innovation, and demographic trends can inform their long-term business outlook.
MYTH: There’s no standard definition or classification system for ESG strategies.
Organizations such as Morningstar, MSCI Inc., and the Forum for Sustainable and Responsible Investment (USSIF) have worked to consolidate and codify ESG product labeling and scoring approaches. The continued efforts of these organizations to label and score funds on ESG-related metrics has helped to improve the classification of sustainable investment strategies. Some, for example, score funds based on the ESG characteristics of the underlying companies. In this case, they are not making a determination about the approach the manager is taking, but aggregating the characteristics of the underlying holdings. MSCI and Morningstar also offer a view into whether managers have an intentional ESG mandate.
Ultimately, we believe it’s best not to take any categorization, label, or rating at face value and instead try to understand a manager’s investment approach and the extent to which ESG considerations are a part of their process. Just as important is determining what type of approach may work for an individual client.
MYTH: Sustainability and impact can’t be found or measured in public market investments.
Let’s start by acknowledging that any investor would be hard-pressed to find a large public company that operates in perfect harmony with ESG ideals. It follows that one would be hard-pressed to find a perfect, 100% impact-oriented portfolio consisting of equity or fixed income securities of large public companies. Nonetheless, ESG investing shouldn’t feel like a fruitless exercise. We advise against allowing the pursuit of perfection to impede progress. While it can be difficult to get clients on board with this notion, particularly if they are especially ESG-minded, explaining the manager’s rationale for owning particular companies – both from a financial and a sustainability perspective – can be persuasive.
When it comes to measuring environmental and social impact, certain metrics are easier to come by. For example, carbon footprint and gender diversity stats are readily attainable and comparable. Product and business involvement is also easily identified. Beyond that, there is more work being done by some asset managers and research firms to assess companies relative to the UN Sustainable Development Goals (SDGs) as a means of measuring sustainability impact. For example, do the company’s products, services and behaviors align with the achievement of the UN SDGs or do they present risks? Products and services can be linked to the SDGs and then a revenue-based approach may be used to measure exposure to them.
For instance, take a wind turbine manufacturer whose practices promote resource efficiency in the manufacturing process, while simultaneously promoting employee well-being, ethical supply chains, and strong community relations. Not only are the company’s products and source of revenue (wind turbines) contributing favorably to the achievement of SDG 7 and 8 (Affordable and Clean Energy and Climate Action, respectively), among others, but their business practices also do not negatively impact other goals. In this case, it can be argued that the wind turbine manufacturer creates positive environmental impact.
MYTH: There are no standards for company reporting or third party ESG ratings.
The reporting and data available to investors regarding ESG factors and metrics continues to improve. In 2018, more than 85% of S&P 500® Index10 companies produced sustainability reporting, compared to just 20% in 2011. Additionally, there has been an uptick in the number of public companies reporting on material ESG risks and trends in their required SEC disclosures and speaking to these issues on quarterly earnings calls. Organizations such as Global Reporting Initiative and the Task Force on Climate-Related Financial Disclosures (TCFD) are helping businesses better understand the risks they are exposed to and helping them measure and communicate this to investors.
Asset owners and asset managers are increasingly relying on third party reports and ratings to assess and measure company ESG performance. This assessment and measurement also often forms the basis of investor engagement with companies on ESG matters. Many providers encourage input and engagement with their subject companies to improve or correct data where applicable.
ESG data providers play an important role by gathering and assessing information about companies’ ESG practices and then scoring those companies accordingly. The development of these ratings systems has helped to nurture the growth of ESG investing by giving asset owners and managers an alternative to conducting such extensive data collection and diligence themselves. Despite the valuable contributions these data providers have made in advancing ESG investing globally, it’s important for asset owners and managers to understand the inherent limitations of this data, as well as the challenges of relying on any one provider, as report and ratings methodology, scope and coverage vary greatly among providers.
When considering ESG strategies, asking both yourself and your clients a few questions about the desired outcome may be a good first step. Including such questions in client and prospecting questionnaires and surveys may also be helpful in directing the conversation. Questions may include:
- Do you believe it is important to invest in companies that are ethically run?
- Are a company’s environmental and social impacts important portfolio considerations from a risk/return perspective?
- Is it important to you to invest in companies that desire to make positive changes in the world through their products or services?
- When you purchase goods and services, are you more likely to purchase from a company with a better reputation?
- When you purchase clothing, food, personal care and other items, do you wonder if it’s ethically produced or made of sustainable and healthy materials?
- Are you trying to limit your personal environmental footprint?
- What types of causes are you passionate about and do you donate time or money to? Is it important to align your wealth with the objectives of those causes?
- How do issues of environmental sustainability and social change affect you, the company you work for and your friends and family?
Investor interest in ESG is growing. A range of motivating factors is leading an increasing number of financial professionals and investors to consider sustainable investment strategies. Understanding these inspirations can play an important role in determining which ESG approach may be best suited to helping your clients achieve their financial goals. However, as inaccuracies about ESG remain prevalent, we believe it is important to ignore – and refute – ill-informed myths and misinformation about the category in order to make more effective and informed investment decisions.
2 Natixis Investment Managers, Survey of US Defined Contribution Plan Participants conducted by CoreData Research, January and February 2019. Survey included 1,000 US workers, 700 being plan participants and 300 being non-participants. Of the 1,000 respondents, 503 were Millennials (age 23-38), 249 were Gen X (age 39-54) and 248 were Baby Boomers (age 55-73).
3 Natixis Investment Managers, Global Survey of Financial Professionals conducted by CoreData Research in March 2018. Survey included 2,775 financial professionals in 16 countries.
4 “SRI Basics.” The Forum for Sustainable and Responsible Investment, December 2018. Online.
5 Natixis Investment Managers, Survey of US Defined Contribution Plan Participants conducted by CoreData Research, January and February 2019. Survey included 1,000 US workers, 700 being plan participants and 300 being non-participants. Of the 1,000 respondents, 503 were Millennials (age 23-38), 249 were Gen X (age 39-54) and 248 were Baby Boomers (age 55-73).
6 MSCI ESG Research, LLC, “Foundations of ESG Investing Part 1: How ESG Affects Equity Valuation, Risk and Performance.” Contributors: Guido Giese, Linda-Eling Lee, Dimitris Melas, Zoltan Nagy, Laura Nishikawa. July 2019.
7 Constituent selection for the MSCI World ESG Leaders Index is based on data from MSCI ESG Research.
8 The MSCI World ESG Leaders Index is a capitalization weighted index that provides exposure to companies with high Environmental, Social and Governance (ESG) performance relative to their sector peers. MSCI World ESG Leaders Index is constructed by aggregating the following regional indexes: MSCI Pacific ESG Leaders Index, MSCI Europe & Middle East ESG Leaders Index, MSCI Canada ESG Leaders Index and MSCI USA ESG Leaders Index. The parent index is MSCI World Index, which consists of large and mid-cap companies in 23 developed market countries. The Index is designed for investors seeking a broad, diversified sustainability benchmark with relatively low tracking error to the underlying equity market.
9 MSCI World Index NR (Net Return) is an unmanaged index that is designed to measure the equity market performance of developed markets. It is composed of common stocks of companies representative of the market structure of developed market countries in North America, Europe, and the Asia/Pacific Region. The index is calculated without dividends, with net or with gross dividends reinvested, in both US dollars and local currencies.
10 The S&P (Standard & Poor’s) 500 Index is an index of 500 stocks often used to represent the US stock market.
Sustainable investing focuses on investments in companies that relate to certain sustainable development themes and demonstrate adherence to environmental, social and governance (ESG) practices; therefore the Fund's universe of investments may be reduced. It may sell a security when it could be disadvantageous to do so or forgo opportunities in certain companies, industries, sectors or countries. This could have a negative impact on performance depending on whether such investments are in or out of favor.