Keeping the SRI in ESG

Big changes are underway in the world of socially responsible investing (SRI). In just the past five or so years, mainstream Wall Street has reversed course from its longstanding claim that SRI can only hurt financial returns, to embrace the idea that environmental and social issues can have a direct impact on financial performance.  

The Wall Street shops are defining their approach as “sustainability” or “ESG” (environment, social and governance) investing. Goldman Sachs recently launched GS Sustain, as “a unique global equity strategy that brings together ESG criteria, broad industry analysis and return on capital to identify long-term investment opportunities.” Mercer, one of the world’s largest investment consultants, built its global Responsible Investment team to “integrate ESG considerations into investment management processes in the belief that these factors can have an impact on financial performance.” UBS has integrated sustainability themes into both its Wealth Management and Global Research divisions, launching products like the UBS Eco Performance equity fund. The former head of Goldman Sachs joined forces with Al Gore to form Generation Investment Management, a firm founded with “an investment approach based on the idea that sustainability factors – economic, environmental, social and governance criteria – will drive a company’s returns over the long term.”  No doubt, the current tumultuous market has presented some bumps in the road for some of the firms involved, but almost certainly the theme of sustainability investing is here to stay.

This is all very positive news for the investment community at large and indeed the planet. These ideas – that people and the environment matter to profits – are just what we’ve been advocating for years! What’s really exciting is there are now more resources and depth to ESG research than we’ve ever had access to before.

But this mainstreaming of sustainability investing also presents something of a threat to longtime SRI practitioners. The new sustainability shops have worked hard to differentiate themselves from traditional SRI – that is, us. The claim is that the new ESG approach improves upon traditional SRI in that it is forward-looking and focused on uncovering investment opportunities in a more sustainable world, without being hampered by negative screening and without taking on controversial shareholder advocacy.

The fact is, forward-looking ESG research is far from new to us. SRI practitioners have been researching and incorporating sustainability concepts into our investment practices for years. For nearly three decades, our research has been focused on the intersections between ESG issues and financial performance – we just didn’t call it that. As we see it, SRI firms have really been providing what could be called “ESG Plus” – adding client-tailored screening, change-making advocacy and high impact community investing on top of our sustainability-focused investment methodology. These “plus factors” are essential to our approach, and for the long-term, we remain committed to keeping the SRI in ESG.

But as the world of financial services restructures, it may be the opportune time for traditional SRI firms to collaborate with Wall Street’s new sustainability initiatives on the ESG mission we have in common. Our experience, dedication and long-term perspective on issues like climate change, water scarcity, poverty, and executive pay, combined with the larger firms’ deep research capabilities and resources could be a powerful force. Indeed, at what may turn out to be a critical inflection point in history, by working together the investment community could play a critical role in defining the path to sustainability.

What Goes Up Doesn’t Always Go Up

The latest disaster in the financial markets has once again shown that some of the biggest risks investors face derive from the excesses of free markets themselves.  This time it was unregulated lending, leverage and speculation.  In 2000 it was over-optimistic and at times corrupt Wall Street analysts, gobbling up creative corporate accounting that massaged income statements to show profits where there were none.

Some of the other systemic risks embedded in financial markets are barely on the radar screen of most investors.  These range from unregulated pollution causing global warming, to the worrisome increase in nuclear proliferation during the Bush years.  Preventable increases in sea levels might warrant more investor attention than, say, which large-cap growth manager should be hired or fired.  There might not have been a worse piece of news for long-term investors over the last decade than Pakistan’s A.Q. Khan passing on nuclear secrets to other countries, yet there is no widespread investor effort to reduce the nuclear threat.

Why don’t investors pay more attention to these massive risks, and try to do more to reduce them?  The answer lies in an almost totemic belief that markets go up in the long run.  In fact, financial asset values don’t inevitably rise, even over twenty and thirty year periods.  Market outcomes are conditioned by the public and private governance systems in which they operate.  By influencing these governance systems, investors working together can reduce market risk and positively influence long-term market outcomes.  To do so, however, will require accepting that markets do not magically inflate, and that investor passivity is in fact a very risky strategy.

Some large institutional investors are starting to wake up to the latent risks in the system and their role in mitigating them.  Investors responsible for over $15 trillion in assets have signed on to the UN Principles for Responsible Investment, which state that ‘environmental, social, and corporate governance (ESG) issues can affect the performance of investment portfolios.”  Investors with over $7 trillion in assets (including Trillium Asset Management Corporation) have joined the Investor Network on Climate Risk (INCR), which has been pushing for more analysis and disclosure of the potential impact of climate change on corporate performance.  Capitalizing on the regime change in Washington, INCR’s members are advocating strongly for improved public policy to ensure global emissions reductions.

It is an enduring irony, last learned during the troubles of the 1930s and 1960s, that no group has a greater self-interest in vigorous public governance than the investor class.  The door has opened for substantial public policy reform not only in the financial sector, but also on other critical issues affecting long-term investor outcomes.  These range from energy and the environment, to health care, income distribution, and global security.  With the widespread use of mutual funds and other diversifying strategies, virtually all investors large and small have a stake in eliminating environmental, social and governance failures in the service of their long-term portfolio returns.  Investors of the world, unite!.