Growing demand for ESG
The demand for ESG investing options is increasing from investors of all types. We see this come through in our research, which shows that 7 in 10 investors want to invest in companies that have a positive social impact and good environmental record.1 In fact, 60% 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
A majority of investors want their investments to align with their personal values, but not at the cost of lower investment returns. 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
Although investors express a preference for more responsible investments, we are not seeing these strategies widely implemented. 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, interpretations, varying implementation methods 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 that may be interested.
Investor motivations: Why ESG?
There are different reasons investors consider ESG investing. Therefore, different conversations and approaches may be necessary for different types of clients. 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 them.
Generally, there are three main investor motivations for implementing ESG. One motivator is values-based, aiming to align investments with an ethical or moral worldview. A second motivator is potential risk/return enhancement. Here, ESG factors are used in investment analysis to better understand an investment’s risk/return potential. 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.
Moving Beyond Myth
Financial professionals who are looking to provide ESG approaches to clients need to know what to ask for – and what they are getting as a potential solution. The table below seeks to challenge many of the biggest misconceptions about ESG and sustainable investing so that the conversation with clients can be more comfortable and productive.
MYTH: No one cares about ESG.
There is plenty of evidence that proves that many investors do care about sustainable investing – and it’s not just millennials. 78% of individual investors worldwide say they want their investments to align with their personal values, and 72% say they want their investments to do social good.4
Despite the fact that ESG is such a hot topic in the financial industry today and that we are hearing preference for these strategies, we believe many investors may not even be aware that ESG investing strategies exist, let alone are available to them. Education on the investment opportunity – the performance, risk implications and product solutions – remains imperative.
MYTH: ESG is just a fad.
The US Forum for Sustainable and Responsible Investment estimates that the size of the sustainable, responsible and impact investing market in the US is already nearly $12 trillion as of 2018 – one-fourth of all professionally managed assets in the US.5 We believe that ESG may become more the norm in investing as the market penetration of ESG-focused products increases and traditional asset managers integrate ESG factors across a larger portion of their business.
MYTH: ESG investments perform poorly.
Perhaps one of the most common myths around ESG strategies is that investors can invest sustainably, or invest to seek returns over time, but not both. However, there have been many academic and industry studies that suggest the integration of ESG criteria may actually lead to better investment performance.
For example, a 2017 MSCI study6 demonstrates how ESG can impact equity performance, risk and valuation. It shows that companies with stronger ESG profiles typically exhibit higher profitability, lower frequency of severe drawdowns, and lower systematic risk. Companies that effectively manage ESG risks and can capitalize on sustainability opportunities may in fact be better long-term investments.
MYTH: Sustainable investing is just a PR/marketing ploy used by asset managers.
There is evidence that a big shift towards sustainable finance is occurring, with some of the world’s largest investors shifting their investments toward sustainable strategies. While we believe that an authentic change of mindset is occurring industry-wide, understanding each asset manager’s history of implementing ESG – their approach, research quality, resources, and investment philosophy – is very important.
Not all asset managers that say they do ESG have a goal of creating positive environmental or social change. For example, some only use a handful of ESG factors in their fundamental analysis, or make simplified stock exclusions such as the removal of tobacco companies from a portfolio. Financial professionals and their clients should have a clear understanding of the ESG approaches they are using, including their potential outcomes and whether they are suitable to their investment objectives.
MYTH: My traditional funds look sustainable as is – why add another ESG fund?
Intentionality is important. Intentional ESG managers work to create portfolios with ESG or sustainability profiles that can persist over time. Additionally, managers that are looking at ESG in a deliberate, purposeful manner may be able to outperform non-ESG managers over time as ESG analysis can provide another layer of risk management, while refining the investment idea-generation process.
MYTH: There’s no place in my portfolio for ESG.
ESG investing is not an asset class or a separate style of investing – financial professionals do not need to create a separate bucket for ESG strategies. ESG strategies 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, you wouldn’t consider only the labels of available strategies. We believe the same should be true of sustainable 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 equity fund may be applied in a portfolio in the same way a traditional equity fund would be, while providing the added benefit of a sustainability mindfulness.
MYTH: There aren’t enough ESG options available to me. I can’t construct a diversified ‘all-ESG’ portfolio.
ESG strategies have existed for decades, and asset managers are launching new products all the time. There are strategies across the major asset classes and strategies offered in different investment vehicles, such as mutual funds and exchange-traded funds (ETFs)7 As of September 2018, there were more than 400 unique open-end funds and ETFs tagged as “socially conscious” by Morningstar, across all major Morningstar categories, with combined assets under management of over $300 billion.
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/or 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: ESG investing is only for tree-huggers and values-focused investors.
You don’t have to spend your whole weekend protesting a particular issue or be devoted to any one particular cause for ESG investing to make sense for you. While an investor may be indifferent to environmental or social development issues, they are less likely to be indifferent to innovations in risk management and developments in long-term business trends that have the potential to benefit their portfolio.
MYTH: ESG strategies involve higher risk.
All investments involve risk, including risk of loss. However, ESG considerations may be utilized as an added layer of risk management. ESG analysis can help identify unsustainable business practices and other underperformance risks, particularly over a long investment horizon.
MYTH: ESG strategies might compromise my fiduciary duty.
We strongly support the DOL’s latest guidelines and believe they are consistent with the original bulletin. In the process of evaluating what is in the best interest of the investor, we believe it is important for financial professionals to consider the ESG components of a company. As a truly active, long-term investment manager, we consider ESG factors as one of the many ways to identify sustainable businesses that have strong management teams and can create long-term value for shareholders.
MYTH: There’s no standard definition for what constitutes ESG.
The continued development by companies such as Morningstar and MSCI to label and score funds on ESG-related metrics has helped to improve the classification of sustainable investment strategies. Nonetheless, we believe that it’s best to take any categorization, label, or rating with a grain of salt and instead try to understand a manager’s investment approach and the extent to which ESG considerations are a part of their process.
MYTH: There are no standards for company reporting around ESG.
While there is still a lot of work to be done on this front, the reporting and data available to investors regarding ESG factors continues to improve. In 2016, more than 80% of S&P 500 Index®8 companies produced sustainability reporting, compared to just 20% in 2011. Organizations such as GRI (Global Reporting Initiative) and SASB (Sustainability Accounting Standards Board) are helping businesses better understand and communicate their impact on the world. Active management and deep ESG research remain key to uncovering risks and opportunities that may not be apparent otherwise.
Talking About ESG: Questions to Consider
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 the 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 environmental footprint?
- What types of causes are you passionate about and do you donate time or money to?
- How do issues of environmental sustainability and social change affect you, the company you work for and your friends and family?
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 what ESG approach may be best suited to achieving the long-term goals of you and your clients. However, inaccuracies about ESG abound. We believe that it is likewise important to ignore ill-informed myths and misinformation about the category in order to make more effective and informed investment decisions.
2 Natixis Investment Managers, Survey of Defined Contribution Plan Participants compiled by CoreData Research, July 2016. Survey included 991 individuals in the US with access to a workplace defined contribution retirement savings plan. Respondents included 661 active participants and 300 non-participants.
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 Natixis Investment Managers, “Trust, transparency and the quest for clarity.” 2017.
5 “SRI Basics.” The Forum for Sustainable and Responsible Investment, December 2018. Online.
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. November 2017.
7 An exchange-traded fund, or ETF, is a marketable security that tracks an index, commodity, bonds, or a basket of assets like an index fund. ETFs trade like common stock on a stock exchange and experience price fluctuations throughout the day as they are bought and sold.
8 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.
Investing involves risk, including the risk of loss. Investment risk exists with mutual funds, ETFs and SMAs. There is no assurance that any investment will meet its performance objectives or that losses will be avoided. The comparisons shown are not comprehensive and may not apply to all mutual funds, ETFs and SMAs. Investors should not make choices solely on the content contained herein, nor should they rely on this information to apply to their specific situation or any specific investments under consideration. This is not a solicitation to buy or sell any specific security.
All investing involves risk, including the risk of loss. Investment risk exists with equity, fixed-income, and alternative investments. There is no assurance that any investment will meet its performance objectives or that losses will be avoided.
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