Almost everywhere we look, someone is talking about environmental, social, and governance (ESG) issues—financial media, investing conferences, even friends and family. Investors have taken notice and continue to add assets, while money managers further expand their sustainable investment offerings. ESG integration strategies have grown rapidly and show potential to add value for investors.
Launched in 2006, the UN-backed Principles for Responsible Investment (PRI) is the world’s leading advocate of responsible investment. According to PRI's 2018 Annual Report, 86% of asset owners reported considering ESG in the selection of external managers, up from 66% in 2010. More recently, the CFA Institute updated its ESG policy to strongly encourage all charterholders to consider ESG factors in their investment process. Managers would be wise to heed this advice. ESG investing, once considered an outlier, has moved to a mainstay of the investment management industry.
Consumer awareness has driven ESG engagement, and this wave of interest has translated to a rapid growth in sustainable investing assets, as money managers have paid attention to their clients’ wishes. According to the 2018 Global Sustainable Investment Review (GSIR), global sustainable investing assets reached $30.7 trillion in 2018, an impressive 34% growth rate from 2016. Since 2014, the U.S. has been the largest driver of that growth at about 16% per year and now accounts for just over 25% of total managed assets.
Global Growth of Sustainable Investing Assets 2016-2018
Source: 2018 Global Sustainable Investing Review
U.S. Growth of Sustainable Investing Assets 2014-2018
Source: 2018 Global Sustainable Investing Review
How has ESG investing evolved?
Institutional investors were early adopters of sustainable investing strategies, but since ESG entered the mainstream, retail assets have grown at a faster rate. While institutions dominated the sustainable investing landscape in 2012, holding almost 90% of assets, by 2018 the steady flow of retail assets pushed their share up to 25%.
ESG strategies have certainly evolved as a broader range of asset owners have been drawn to sustainable investing. Though there are now numerous sustainable investment strategies available, negative screening and integration account for the vast majority of global assets. Negative screening remains the most common global strategy, but integration is rapidly gaining in popularity. Between 2016 and 2018, assets allocated to ESG integration grew at more than twice the rate of negative screening. Integration is particularly popular in the U.S., which accounts for more than half of global assets using this strategy.
Benefits of ESG integration
The shift to ESG integration strategies reflects their potential to add value to actively managed portfolios. Rather than simply excluding certain investments, an integrated approach allows managers to leverage the expertise of their investment teams in evaluating ESG factors. However, not all ESG data is relevant to every company. Assessing the materiality of a given factor to a company’s financial performance is central to a successful integration approach. Analysts with sector-specific rather than ESG-focused expertise may be better positioned to determine the relevant factors and the overall impact they could have. It is likely that analysts already incorporate some of these factors into their analyses, at least implicitly, but an integrated approach allows them to do so in a more explicit and systematic way.
This approach requires more consistent and high quality ESG data than a simple screening approach. Until recently, a lack of standardized data made it difficult for investors to convert their interest in sustainability into investments with a focus on ESG integration. In response to the wave of investor interest, managers have been inundated with new resources. Companies continue to increase their sustainability disclosures. MSCI and Sustainalytics have taken the lead in using this information to provide ESG specific data and research, but others across Wall Street have also become involved.
So with all this new information, investment teams are better informed of sustainability considerations and are able to incorporate more high quality ESG-focused information into their decision-making process. Not only can ESG integration deepen fundamental analysis by providing a more nuanced picture of a company, it can also enhance the process of identifying long-term risks and uncovering high quality opportunities. Over time, the hope is that these shifts lead to better overall outcomes for both asset owners and managers.
Principles for Responsible Investment Annual Report: 2018, 2010
Global Sustainable Investment Alliance – Global Sustainable Investment Review: 2018, 2014
This represents the views and opinions of GW&K Investment Management. It does not constitute investment advice or an offer or solicitation to purchase or sell any security and is subject to change at any time due to changes in market or economic conditions. The comments should not be construed as a recommendation of individual holdings or market sectors, but as an illustration of broader themes. Data is from what we believe to be reliable sources, but it cannot be guaranteed. GW&K assumes no responsibility for the accuracy of the data provided by outside sources.