ESG factors gaining global exposure

Institutional investors across the globe are becoming more aware of the environmental, social and governance effects both of, and on, their investment choices.

What is also clear is there is no one-size-fits-all response to addressing this awareness, and some executives say the theory is not necessarily translating into practice.

“We are seeing some asset owners think very clearly about what they invest in, particularly endowments and foundations and religious organizations, as these tend to be more mindful of the ethical nature of their investments,” said Jane Goodland, London-based senior investment consultant at Towers Watson & Co. (See related story at www.pionline.com/esgextra.)

One example in the U.K. is the Church of England's £6.1 billion ($10.5 billion) investment fund, whose investment restrictions were tightened last month by the church's Ethical Investment Advisory Board Group. The advisory board reduced revenue thresholds to 10% from 35% on screening out companies on account of their involvement in tobacco, gambling, high-interest-rate lending and human embryonic cloning.

“We reviewed whether it was appropriate to have these thresholds, and decided that 10% was more appropriate,” said Edward Mason, London-based secretary to the Ethical Investment Advisory Group. “We took into account that screening is more sophisticated, that we can get more granular data on the companies and revenues on the activities that we are trying to avoid.”

Mr. Mason said the EIAG and national investing bodies always assess the investment impact of proposed restrictions. The tightening of these screens has, he said, resulted in additional companies being excluded from investment, but the impact “was not judged to be likely to impact on the investing bodies' ability to achieve their investment targets.”

But most institutional investors do not have such strict policies.

“The majority take a fiduciary approach,” said Jane Ambachtsheer, partner and global head of responsible investment at Mercer Investments in Toronto. She said stewardship is a part of ESG, with the first code in the U.K. and “six or seven more across the world” that aim to enhance the engagement between money managers and companies — not only promoting the idea of good stewardship and responsible investment, but also helping improve the long-term returns delivered to shareholders.

There are also initiatives to push Ontario-based institutional investors to disclose their statement of investment policies and principles, with the government announcing proposed regulations in April for Ontario-registered pension plans.

“It is soft-touch and I believe it will function as a catalyst to get other investment committees to focus on this,” said Ms. Ambachtsheer. The regulation is expected to be effective in January.

But one consultant said that, for the increased conversation on the topic over the last year or so, the numbers are not a reflection. “(ESG) is a topic we have been speaking to trustees about a lot more,” said Ciaran Mulligan, global head of manager research at consultant Buck Global Investment Advisors in London. “We all know the benefits of ESG investment over the long term. However, in practice, the amount of direct ESG mandates that we have seen trustees invest in is perhaps not reflective of the talk. There is not as much change to asset allocation policies as we would expect.”

“As the pressure continues, we will probably see a steady increase in the amount of (ESG) funds being launched in the U.S. and the U.K., and with that there will be new benchmarks too. But it is early days — although trustee boards will force fund managers down that road,” said Mr. Mulligan.

One of the problems might be the lack of ESG-focused pooled funds, particularly for asset owners too small to invest in separate accounts, he said.

The Global Sustainable Investment Alliance's most recent investment review, published in January 2013, showed that ESG investment selection and management covered $13.6 trillion of global assets in 2012. Europe accounted for 64.5% of the assets; the U.S., 27.6%.

“There is a growing awareness of ESG issues and their potential impact on investment returns,” said Towers Watson's Ms. Goodland. “We are seeing some corporate pension funds becoming more mindful and recognizing that there are issues out there that haven't made it into the analysis of equity research, but which could be impacting the value over the long-term.”

Investment in ESG strategies has increased, although not at a steady pace. Figures from data provider eVestment LLC show sharp increases and decreases in the asset levels within its global ESG institutional database, reflecting fluctuating interest in the strategies and that eVestment's universe of data has increased over time. Therefore, said Peter Laurelli, New York-based vice president and head of research at eVestment, it is important to look at the assets under management in conjunction with the flow information. “Looking at this information we can see that ESG as a strategy appears to have grown significantly over time, but also there have been variable flows over the last several quarters,” he said.

The latest data showed assets under management in ESG strategies totaled $102.9 billion for the first quarter of 2014, following inflows that quarter of $3.7 billion. That compared with $40.4 billion for the same period in 2013, with outflows of $2.9 billion.

But some pension fund executives continue to assert that ESG rules on portfolios will constrain managers and, therefore, returns. “That could be true depending on the degree of constraint, but the main thing about delivering value is the skill of the manager and the team,” said Ms. Goodland.

“As to whether investing "ethically' necessarily results in lower returns, the evidence is not necessarily clear,” said Will Pomroy, London-based policy lead: stewardship and corporate governance, at the National Association of Pension Funds. “Certainly in many cases, there is greater risk of volatility and commonly reduced short-term returns. However, there is much development taking place within the ethical investment space and the common view that ethical investing means lower returns is being tested.”

But pension funds looking at the indexes to make a decision might have been deterred from going whole hog into ESG.

The MSCI KLD 400 Social index — covering 400 U.S. companies with very high ESG ratings relative to the U.S. investible index — returned 23.3% for the year through June 30, against a 24.83% gain for the MSCI World.

Compare that with the Vice Fund, a $320 million mutual fund that invests in companies with significant involvement in, or with substantial proportions of revenues deriving from, tobacco, gambling, defense and weapons and alcohol industries. That fund returned 23.77% over the year through June 30. It also outperformed the social index over three-years annualized, at 17.37% for the Vice Fund vs. 14.29% for the MSCI KLD 400 Social index. Over five years annualized the outperformance continues, with 19.4% for the Vice Fund against 16.18% for the ESG-invested index. n