Use of economic, social and governance factors is here to stay, according to a survey conducted jointly by Pensions & Investments and the Social Investment Forum.
Two-thirds of investment consultants believe the economic crisis had no impact on client interest in integrating environmental, social and governance factors into their portfolios, the survey found. Nearly one-fourth said the crisis actually heightened client interest, according to the survey released Dec. 2.
“I'm theorizing that people are linking the financial crisis to irresponsible practices — socially irresponsible and financially unsustainable,” said Meg Voorhes, deputy director and research director of the Social Investment Forum, Washington.
Ms. Voorhes added that she was heartened by the “near unanimity” in consultants' predictions that client interest in ESG integration would grow over the next three years.
The survey of 40 consulting firms — ranging from more than $1 trillion in assets under advisement to less than $100 million — found 88% of consultants expected greater client interest in ESG integration in the future. Fifty-six percent noticed greater client interest in the 12 months preceding the e-mailing of the survey in September.
“Perhaps there was a pause in discussions in moving ahead” with ESG integration because of the recession, said Jessica Matthews, the Arlington, Va.-based manager of Cambridge Associates LLC's mission-related investing group. “I haven't seen any long-term effect. It was more like being postponed on the (client's) agenda. We're now seeing an increase (in interest) again.”
Sarah Cleveland, a senior consultant for Watson Wyatt Investment Consulting based in Lake Oswego, Ore., said the recession “has had a positive impact on inquiries” about ESG integration strategies. “The headwind is the misperception that you won't perform as well (with ESG principles) as you would with the broader market.” Ms. Cleveland is a member of the Social Investment Forum's board.
Perception by both consultants and clients will play an important role in developing ESG integration policies.
For example, the survey asked consultants if six criteria help or hurt portfolio performance. The six factors are: proxy voting; corporate engagement; exclusion of stocks and bonds in portfolios; integration of ESG analysis into investment decision-making; “best-in-class” inclusion of certain stocks and bonds; and positive selection based on sustainable themes such as climate change.
A plurality of consultants — ranging from 38% to 49% — believed each of five ESG factors improved portfolio performance. For these criteria, 10% or fewer of the respondents thought each factor hurt portfolios' returns.
However, only 8% believed that excluding stocks and bonds from a portfolio — known as negative screening — improved a portfolio while 41% said this approach weakened a portfolio's performance.
This is an interesting counterpoint when compared with another survey question: For which ESG integration strategies do consultants offer advice? The most common advice (64.9%) was negative screening, followed by positive selection (51.4%). Consultants were least involved in advising on proxy voting (37.8%) and corporate engagement (35.1%).
Although many institutions emphasized negative screens many years ago, the ESG strategy has expanded since those early days.
“Clients are looking more proactively rather than just giving managers a list of securities and saying, ‘Don't invest in this,' “ said Ms. Cleveland.
“Negative screening is still a large market, but you're seeing a broadening of focus,” said Craig Metrick, who directs U.S. operations for Mercer Consulting's responsible investment business unit in New York. Among clients with whom his group spends the most time, key topics are how corporate governance and climate-based issues affect long-term portfolio performance.
One example of clients' desire for a wider focus, Mr. Metrick said, can be found in an uptick among defined contribution plans reviewing existing mutual-fund offerings for a comprehensive ESG integration strategy rather than just adding a single socially responsible fund to their menu. “It's not a tremendous wave, but it shows they are trying to be more proactive,” he said.
Despite the survey's generally favorable results on the ESG criteria, officials at the Social Investment Forum expressed surprise at the large percentages of consultants who said they couldn't detect — or didn't know if — ESG factors affected portfolio performance. In each of the six categories, 44% to 59% of respondents said they believed ESG integration didn't affect portfolios or that they didn't know if ESG had any impact.
The consultants' uncertainty comes at a time when academic researchers are producing more studies trying to assess the impact of ESG on portfolios.
A November report by Mercer Consulting looked at 16 academic analyses, noting that 10 detected a positive relationship, four found no impact and two produced mixed results.
When Mercer pooled these reports with other studies the firm examined in a 2007 report, it said 20 studies showed a positive relationship, three reported a negative relationship and eight were neutral. The other studies contained mixed results.
The Mercer report emphasized that ESG integration isn't a magic bullet: “A variety of factors, such as manager skill, investment style and time period, is integral to how ESG factors translate into investment performance.”
. Even with the ESG research and with expectations of greater client interest, the P&I/Social Investment Forum survey found that just 22% of consultants raised this issue as standard procedure when they meet clients. Seventy-one percent discuss ESG only when clients ask.
The survey said consultants' reticence might be due to their wanting more data on ESG integration's impact on different asset classes over long periods of time. Some consultants said their firms — or consulting firms in general — needed to improve in-house ESG expertise to address future demand.
When asked how many full-time employees specialized in ESG, 15 of the 38 firms responding to this question said they had none. Four had less than one full-time-equivalent staffer working on ESG matters. Although smaller firms lacked full-time ESG staffers, several companies with 20 to 100 investment consultants also lacked ESG integration specialists.
“One or two respondents were dismissive of ESG, but they were the outliers,” the Social Investment Forum's Ms. Voorhes said. “In general, people were interested. Several said they needed to develop their own expertise.”