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Industry Voices

Commentary: Creating a virtuous circle for ESG-minded investors

We have seen many studies that suggest the attitudes of younger generations will generate a substantial rewriting of both the political and investment landscape in the years to come. Morgan Stanley (MS)'s "Sustainable Signal" study, published in August, shows a strong appetite for, and optimism about, the effects of sustainable investments from the majority of millennials, typically defined as those born 1982 to 1995.

Pension funds are responding in force. The California Public Employees' Retirement System's five-year environmental, social and governance strategic plan was adopted in August 2016. The New York State Common Retirement Fund enhanced the ESG component of its manager selection earlier this year.

The investment offerings are emerging, but even liberal minded millennials show some of the age-old reservations about the possible impact of ESG considerations on performance. We believe an active ESG focus from institutional investors — directed at companies that have work to do in this arena — is necessary to help millennials overcome qualms and fuel future demand for ESG-conscious investment strategies. That focus also should reward those active investors with stronger long-term returns. There can be a virtuous circle for ESG-minded investors.

'Trade-off' myth + financial pressures = trouble for ESG

While the investment industry is starting to grasp that companies that make sustainability a priority can be a very good bet in the long term, even those among the younger generation who are passionate about sustainability are not necessarily sold on the financial case. Millennials actually believe the "trade-off" myth more than their parents and grandparents do — the one wrinkle in the aforementioned Morgan Stanley (MS) study.

Throw into the mix the desperate struggles of clearing student debt and getting onto the housing ladder, slow starts to saving for retirement and the Social Security shortfall, plus the inconvenient truth of ever later retirement ages thanks to increasing longevity, and the misguided perception that sustainable equals lower returns begins to matter an awful lot.

New research shows that, burned by early memories of the dot-com bust and financial crisis, millennials aren't investing enough in the stock market. With the resources they do direct into stocks, it's understandable they are going to want to pick winners. The perception that ESG is focused on screening out less sustainability-driven companies can take solid stock performers out of the pool and further exacerbates the trade-off myth.

Generational shift of assets creates opportunity

Older baby boomers are now into their 70s and the next decade will see an enormous wealth transfer to millennials as they capture executive jobs vacated by retirees and receive inheritances from parents and grandparents. Millennials and Generation Zers, the generation after millennials, born roughly 1996 to 2010, will soon, collectively, be investing trillions of dollars. Make no mistake, thanks to the prevailing sentiments of younger Americans, more investments will be directed toward companies conscious of their carbon footprints, to companies that have greater diversity on corporate boards,treat employees well and have healthy governance.

However, there are things that today's institutional investors can do to create a more fertile environment for younger ethical investors, and at the same time improve their own returns.

Demand change to meet future demand

There is a strong financial case for active ESG investing right now for institutional investors. For long-term investors, using this lens to encourage companies in their portfolios to become more sustainable and ethical might mean larger returns as demand for ESG stocks increases with younger generations accumulating more assets over the next few decades. Instead of purely screening out particular stocks, institutional investors can seek to influence management and boards, making the stock they hold more likely to be acceptable to future ESG investors who take a purely "screen-out" mentality.

A more committed approach to stewardship can create a virtuous circle for ESG investing. For example, at Addenda we have lobbied management at a number of industrial companies within our global equities portfolio to improve a lack of transparency on climate change risk and opportunity identification and management. In correspondence we have pinpointed a lack of participation in the Carbon Disclosure Project and laid out a strong case as to why these companies should participate.

It is also critical that institutional investors use proxy-voting powers to encourage change. This might mean voting against board chair nominations or committee chair positions where boards and management teams do not reflect the diversity of their stakeholders.

One sure way for millennials to move past their "trade-off" hang-up is if they see large, successful companies that generate handsome returns and dividends for investors, making significant strides on corporate social responsibility, diversity and other sustainability initiatives. Institutional investors can help make that happen through committed stewardship.

The path forward

All of our research suggests sustainable investing is a synonym for good long-term investing. However, an article by Robert Pozen, published by the Brookings Institution in August 2015, however, larger institutional investors have allowed aggressive activism from short-term focused investors like hedge funds to sway management's decision-making. That will leave some of these companies wanting in many of the key criteria younger investors will be evaluating.

A renewed focus on stewardship will power a virtuous circle of ESG investing. It can break the pattern of harmful short-termism and can put the business community in the driver's seat to answer some of the world's biggest challenges, while certain governments demure. It is this effort that will answer the growing demand of millennials, and the generations that follow, for sustainable investments that do not raise fears of a financial trade-off.

Above all, this virtuous circle can add substantial value to the investors that take the lead.

Brian Minns is manager, sustainable investing, at Addenda Capital Inc., Toronto. This content represents the views of the author. It was submitted and edited under P&I guidelines, but is not a product of P&I's editorial team.