In the movies and the popular imagination, Wall Street is all about the money, and doesn’t have much heart. Think of Michael Douglas’ Gordon Gekko extolling the virtues of greed, or Leonardo DiCaprio’s Jordan Belfort breaking laws both financial and moral in The Wolf of Wall Street. But if investment trends in environmental, social and governance (ESG) issues are any indication, Wall Street does care — about repressive regimes, greenhouse gas emissions, reasonable gun control and other heart-rending topics.
Investing with a conscience is gaining ground. In the U.S., sustainable, responsible and impact investing has grown to $6.57 trillion in U.S.-domiciled assets under management at the start of 2014, according to the Forum for Sustainable and Responsible Investment, also known as US SIF Foundation. That’s a 76 percent rise from $3.74 trillion under management at the start of 2012.
What’s more, heart-wrenching news events that paralyze the country can have an impact on the investing community as well. The reaction of institutional investors to the massacre at an elementary school in Newtown, Conn., was reflected in investing statistics, according to Meg Vorhees, US SIF director of research and operations. “Since 2012, we have seen a fivefold increase in policies that restrict investment in firearms and weapons manufacturers,” she said in a recent online presentation for US SIF’s latest investment trend report.
It’s not all emotions, however. Investing with a conscience may in fact deliver higher returns. Seventy-six percent of respondents in US SIF’s recent report on investing listed returns as a motivator for their ESG investing strategies. Last summer, in a research report on ESG investing, New York-based asset management firm New Amsterdam Partners found a clear correlation between ESG strategies and returns. “Higher return companies, in aggregate, had better ESG ratings,” wrote Indrani De, New Amsterdam Partners’ senior director of quantitative research, and Michelle Clayman, a managing partner and the firm’s chief investment officer.
“A useful way to think about it is that environmental and social factors can help us to identify company risks,” said Jonas Kron, director of shareholder advocacy for Trillium Asset Management. For example, an oil company with seemingly minor environmental or safety violations may in fact be at higher risk for a larger accident that could affect returns, he suggested.
In recent years, a variety of topics have helped push environmental and social issues to the forefront. The conflict in Darfur prompted many organizations to “divest” or economically boycott Sudan. Four states (Illinois, New Jersey, Oregon and Maine), at least 17 universities and numerous rights groups joined the boycott.
Organizations pushing to raise awareness of climate change have also spurred increased investing tied to environmental causes.
“As Bill McKibben and 350.org have made very persuasive arguments on why institutions should not be invested in fossil fuel companies, we have seen increasing interest from existing clients and new clients who want to work with an asset manager who knows how to manage either a fossil-fuel-free or low-carbon portfolio,” Kron said.
Environmental and Social Benchmarking
One further indication of the growth of these asset classes is the advancement of tools and indexes aimed at supporting sophisticated investors in ESG causes. Brian Upbin heads benchmark index research at Barclays, which in 2013 formed a partnership with market index, data and risk management company MSCI to jointly develop indexes that target environmental and social issues. The latest index to come out of the partnership targets the growing interest in “green bonds.” According to the Climate Bond Initiative, more than $35 billion in green bonds had been issued in 2014 as of mid-December, and the total for 2015 is projected to be $100 billion.
“What this index came out of was a recognition of an emerging new asset class within the fixed income space,” Upbin said about the Barclays MSCI Green Bond Index. “The market is relatively small and relatively young, but it’s growing at a pace where enough investors are starting to look at it as a distinct asset class.”
The challenge in creating an index for an emerging ESG asset class, according to Upbin, is in ensuring that the index aligns with the way the new asset class is defined by its investors.
“I think one of the challenges or objectives is to make sure that the index has a clear definition of what a green bond is, so that it can be independently evaluated and not just reliant on an issuer coming to market and saying this is a green bond. There has to be a method of verification, validation and evaluation that this is truly a green bond,” Upbin said. “It’s a market we continue to actively monitor and actively evaluate to make sure that the criteria we have in place are representative of how investors think of it.”
The Barclays MSCI Index rebalances monthly, so that each time a bond comes out that meets the inclusion criteria, it is added to the index for the following month.
“Right now the green bond market is very small in the context of the overall fixed income market,” Upbin said. “One of the reasons we launched the index now is to help provide standardization and measurement and evaluation of the market, so that as it grows in size you can expect to see potentially more interest.
Responsible Investors
Green bonds, Upbin said, like other ESG asset classes, appeal to two different types of investors. There are dedicated environmental investors, as well as crossover investors for whom green bonds are part of a larger portfolio.
In fact, according to US SIF, the ESG investor base is actually very diverse and includes banks, money managers and institutional investors who engage in social and environmental investing for a variety of reasons.
According to US SIF’s 2014 trends report, “There is no single motivation for pursuing sustainable impact investing. Some investors are driven by their personal values and goals, their institutional mission, or the demands of their clients, constituents or plan participants.”
US SIF identified more than 300 investment advisors managing 925 investment funds and 214 separate accounts that included ESG criteria in their portfolio selection at the start of 2014, as well as 880 community investing institutions.
In terms of how investors approach responsible investing in these causes, however, there are two main strategies, and investors generally follow one, the other or a combination of the two. The first strategy is a more traditional investing approach and involves using ESG criteria in portfolio selection and in analysis of investment decisions. The second method involves the growing trend of shareholder advocacy, where investors or their representatives may leverage shareholder power to push companies to adhere to more socially and environmentally responsible investing.
Shareholder Advocacy
Trillium Asset Management employs both of these strategies. The company, which runs separately managed accounts and manages portfolios for foundations, endowments, pension funds and high-net-worth individuals, makes investments based on environmental, social and governance scores, rankings and metrics. Often, however, after portfolio selection Trillium continues to push for ESG issues.
“There is a lot of gray area, and there are companies that may have strong social stories, which may be why they are in our strategies, but they have environmental issues, or vice versa,” Kron said. “While the companies are in our strategies for a reason, they are rarely perfect and there are always opportunities to have those companies do better. There are also emerging issues that come along that weren’t issues when we first invested in a company, things like cybersecurity and privacy issues.”
In those cases, Trillium advocates change through dialogue with company management or through actions like shareholder proposals. These proposals, which are essentially ballot measures, are non-binding and cannot force management to make any changes, but often a show of strength on an issue in a shareholder proposal can influence management to address investor concerns. Trillium files approximately two dozen shareholder proposals a year, making it one of the larger filers, particularly for its size, Kron told Traders.
Shareholder proposals don’t need to attract a majority of votes to be effective, according to Kron. When you consider that a large individual investor can often make waves with a 5 percent stake in a company, shareholder votes just need to get a strong showing to potentially have an impact. Citing a recent shareholder vote related to a company’s methane emissions that received 28 percent approval among shareholders, Kron noted that while far from unanimous, the result contributed to the company improving disclosures.
“Shareholder proposals on average get 20 percent of the vote, so this was almost 50 percent higher than the average vote and that’s a very strong message from my point of view,” he said. “Keep in mind that top shareholders are often large mutual funds that may vote with management out of habit or not vote at all, so in terms of the number of shareholders actually considering the proposal, that 28 percent number could be considered much higher.”
In another example that did not involve a shareholder proposal, Trillium assembled a group of investors to approach Apple about adding more women to the company’s board of directors. Aside from an equality issue, Kron said research from Credit Suisse and others has demonstrated that companies with more women on their board of directors outperform their peers financially.
Following the discussions, BlackRock’s Sue Wagner joined Apple’s board of directors, becoming the second woman on Apple’s board.
Founded in 1982 as a place for clients to make investments in line with their values, Trillium is one of the early players in the space. Aside from statistics on investment dollars, another trend cited by US SIF as an indication of the growth of ESG investing is the list of companies that make up its own membership.
As US SIF’s CEO Lisa Woll put it: “In the beginning, we had the early actors like Calvert Investments and Trillium Asset Management, but now firms like Bloomberg and Morgan Stanley have joined.”
