The integration of environmental, social, and governance (ESG) factors into the institutional investment analysis and decision-making process is a mega-trend that investors can no longer ignore, says Emily Chew, global head of Environmental, Social, and Corporate Governance Research and Integration at Manulife Asset Management.
Speaking at the 71st CFA Institute Annual Conference in Hong Kong, Chew noted that there is a mindshift taking place in the financial industry that has both asset owners and managers increasingly treating ESG investing as part of their fiduciary duty. Further, clients are also demanding responsible investing, seeing it not only as a means of doing good, but also as a way to increase portfolio returns and manage risk.
According to the Global Sustainable Investment Alliance, there were nearly $23 trillion in assets being professionally managed under responsible investment strategies at the end of 2016. That was about 26% of all professionally managed assets globally. Europe, the United States, and Canada were the largest regions in terms of assets under management (AUM), with Japan, Australia/New Zealand, and Canada showing the fastest growth over the prior three-year period. The number of signatories to the Principles for Responsible Investment (PRI), the world’s leading advocate for responsible investing, has grown from 100 at its launch in 2006 to approximately 1,800 today.
What’s driving the growth of ESG investing? Chew cited several factors:
- Improved risk-adjusted returns: A State Street Global Advisors survey of global asset owners revealed that 68% found ESG integration to have significantly improved their portfolio returns. A separate study by MSCI, “Can ESG Add Alpha?” found that portfolio construction employing an ESG momentum (improving ESG scores) strategy delivered an annualized active return of 2.2% over a seven-year period. Applying an ESG lens to the investing process may also help manage risk, avoiding common ESG shocks like labor stoppages, accounting fraud, and supply chain disruptions. Bank of America Merrill Lynch researchers also found ESG investing to mitigate price risk, earnings risk, and even existential (bankruptcy) risk.
- Growing influence of consultants: Chew noted that, “consultants like Mercer are leading the charge” into responsible investing, and a simple policy statement on an asset manager’s website is not enough. Mercer has developed a four-factor model that measures the depth of a manager’s commitment to ESG investing principles. Asset managers have come to understand that passing muster with consultants is a prerequisite to gathering assets in the ESG space.
- Increasing demand from millennials: Research performed by the Responsible Investment Association (Canada) found that “Millennial investors are 65% more likely than Boomers to consider ESG factors when making investment decisions,” and “almost twice as likely as Boomers to believe that companies with good social and environmental practices are better long-term investments.” With millennials currently making up 27% of the global population and poised to become the dominant generational cohort, their preference for responsible investing would be foolish to ignore.
- Compliance with public policy initiatives: In 2016, the PRI identified almost 300 regulations and codes in the world’s largest 50 economies which supported ESG investing, and most of these were created since 2013. These policies are compelling greater disclosure on the part of companies with respect to ESG-related risks, as well as improved transparency on ESG policies and a greater sense of stewardship within the investment community.
- Evolution of fiduciary duty: The notion of fiduciary duty is evolving to encompass certain principles that are core to responsible investing. As Chew’s firm, Manulife Asset Management, sees it, “How we exercise due care, skill, and diligence evolves as the world changes. ESG analysis can raise important pre-financial information that our fiduciary obligations require us to consider.”
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