Sustainable strategies on growth track in U.S.

Investments in sustainable strategies are growing rapidly in the U.S. as more investors look to drive investment returns and social good at the same time, and money managers design new products to meet demand.

Assets under management in U.S. mutual funds and exchange-traded funds using an environmental, social and governance-only approach reached $200 billion at the end of February, up 5.8% from Dec. 31 and up 17% from year-end 2015, Morningstar Inc. data show. The data do not include institutional separate accounts or ESG assets managed internally by U.S. pension plans.

But the growth in ESG investing, which long has had a foothold in Europe, goes beyond ESG-only strategies:

• Money managers in the U.S. increasingly are applying an ESG lens across investment strategies and asset classes.


• New ESG products are being provided to U.S. investors, including first-in-the-market offerings such as ESG-oriented target-date funds.


• Large U.S. institutional investors increasingly are asking their external managers to show how they are using ESG factors in their investment processes.

In the 14 months ended Feb. 28, more than 40 U.S. money managers agreed to follow the guidelines promoted by the United Nations-backed Principles for Responsible Investment, which urges integration of ESG policies firmwide.

Among recent signatories are Fidelity Investments and Brandywine Global Investment Management LLC. PRI now lists 244 U.S. money managers among its more than 1,700 followers, a more than 20% increase since the end of 2015.

Fidelity Investments, Boston, recently opened an ESG unit in its asset management division “to support the integration of ESG considerations into our investment process,” said spokeswoman Nicole Goodnow in an e-mail. While Fidelity's investment process had always been consistent with PRI principles, Ms. Goodnow wrote, “as we continue to focus on enhancing our consideration of ESG factors, we felt now was the right time to formalize our commitment and become a PRI signatory.” Fidelity, with $2.2 trillion under management, signed the principles on Feb. 23.

Philadelphia-based Brandywine, with $70 billion under management, has expanded the use of ESG in all investment strategies, said Adam Spector, the firm's managing partner, in an interview. Brandywine has no dedicated ESG strategies but has been using ESG guidelines to assess risk in companies for several decades in its fundamental equity strategies, he said. The company did not begin using an ESG framework for its quantitative strategies until several years ago because of a lack of adequate metrics, Mr. Spector added.

Mr. Spector said Brandywine only signed the PRI agreement in December after it felt comfortable that an ESG framework could be applied companywide. There now is more available ESG data and multiple vendors who provide this information, he said.

Money managers also are promising to engage more with companies about ESG issues like climate change. BlackRock Inc., which had come under criticism from some shareholders for not challenging corporate management on climate change, announced in March that enhanced climate risk disclosure will be an area of focus for the $5.1 trillion manager's investment stewardship team this year.

The growing embrace of ESG principles by large U.S. institutional investors means money managers must have an ESG investment plan if they want to gain or retain clients.

In a March report, the New York State Common Retirement Fund said it will use a new model to score all of its fund managers on ESG policies and performance.

“The fund will work to ensure that the (ESG) risk assessment guides its consultants' due diligence on potential managers' ESG policies, and builds the fund's internal perspective on what policies drive ESG performance,” the report said.

A pilot program began about six months ago, Matthew Sweeney, a spokesman for New York state Comptroller Thomas DiNapoli, sole trustee of the $186 billion pension fund, said in an email.

Officials believe “ESG factors can affect financial performance and should factor into investment decisions when they are material,” Mr. Sweeney said in a separate email.

The nation's largest pension plan, the $313.2 billion California Public Employees' Retirement System, Sacramento, is conducting an assessment to determine the best way for external money managers to use ESG in their investment process. At a March 13 investment committee meeting, detailed ESG engagement plans were issued for managers tht invest in global equity, fixed income, real estate and private equity. The new criteria will include annual reviews of some managers, which will be required to detail their ESG practices.

The $202.1 billion California State Teachers' Retirement System, West Sacramento, also announced last week its first social bond investment. Its contributed $5 million toward a $500 million bond purchase with 39 other institutional investors. Proceeds will go toward financing women-owned enterprises in low-income communities in emerging markets.

CalSTRS already requires external managers to use ESG guidelines and is looking at expanding its lineup of ESG-only firms, announcing in October it was searching for up to 10 ESG managers.

Driving the increase in ESG activity are women and millennial investors, said Jeb Doggett, a director with consulting firm Casey Quirk by Deloitte in Darien, Conn. He said ESG investing has been slower to gain traction in the U.S. But in Northern Europe, it is “almost a requirement to do business.”

Of the new ESG-only strategies, Jon Hale, Chicago-based director of sustainability research for Morningstar, particularly likes the suite of ESG-oriented target-date funds offered by Natixis Global Asset Management. He said the funds could have the potential to garner significant assets because no other manager is offering such a concept. It gives Natixis the ability to penetrate a U.S. retirement market dominated by three firms — Fidelity, Vanguard Group Inc. and T. Rowe Price Associates — that it could not compete with unless it had some kind of a unique offering.

Competition from other established defined contribution plan money managers is likely if Natixis is successful, Mr. Hale said.

Ed Farrington, Boston-based executive vice president retirement services for Natixis, said a company survey of retirement plan participants showed 71% of millennials would contribute more to a retirement plan if they knew it was doing a social good. He said his firm is now negotiating with plan sponsors and record keepers, and there has been “strong interest.” He was unable to provide further specifics.

Ultimately, Mr. Hale said, the success of the ESG strategies will depend on whether money managers can show consistently strong investment performance.

An April 2016 study by TIAA-CREF (now Nuveen) that looked at responsible investing equity indexes over the long term found “no statistical difference in returns” when compared to broad benchmarks.

A November 2016 report by Barclays Research tracked the Bloomberg Barclays U.S. Investment-Grade Corporate Bond index with diversified portfolios, matching key index characteristics but with a tilt, negative or positive, toward ESG factors. The report found the positive ESG investment tilt resulted in a “small but steady performance advantage.”