In-Depth

The Capitalists’ Guide to ESG

Is it possible to create real financial value from doing good?

“Ten years from now, I don’t think we’ll still have a label for environmental, social, and governance (ESG) investing,” begins Jagdeep Bachher, CIO of the University of California (UC).“In the past—even for those called pioneers in this space—ESG investing had been about checking the boxes and filling in a scorecard: How much of your portfolio is earmarked for specific ESG strategies this quarter? Which security will you be excluding today? But now, we’re investing in an age where we cannot ignore what is happening with climate change and its risks. We have to look at how to embed ESG needs into the entire investment decision-making framework and evaluate that risk in a holistic way. And this is what we’ve begun doing at the University of California.”

Last September, UC announced it would actively gear its entire $91 billion retirement and endowment portfolio for climate change, focusing especially on solar energy projects. The university also vowed to invest $1 billion over five years into finding solutions for the mutating climate. It joined the United Nations-supported Principles for Responsible Investment, and promised to uphold them.

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“We have learned that embracing ESG cannot be simply about one narrow strategy, like divestment,” Bachher continues. “It’s about going beyond: Reevaluating the way we make our investment decisions and implementing values that change our DNA and culture. It’s not enough to satisfy the sustainability police.”

However, the sustainability police are currently the loudest voices on the topic of ESG investing. Often in the shape of student groups and grassroots movements, they target institutions with demands that they divest from coal, oil, and gas holdings, dominating news headlines and occasionally administrative meetings. Groups like 350.org ask organizations to “immediately freeze any new investment in fossil fuel companies” and divest from direct ownership and commingled funds that include such ownerships within five years. The operation makes clear that what they’re pushing isn’t purely an economic strategy, but rather a political and moral act (at least in their view). These dimensions, however, can undermine investors’ ability to fulfill their fiduciary duties and maximize risk-adjusted returns. Hitting one’s investment target is hard enough with just one bottom line, many asset owners say, nevermind two or three. When student groups pushed Bachher last September—then very new into his role—to divest, he issued a statement saying, “the university is not in the business of taking the easy route.” Instead, he said reconstructing the investment framework would likely “be more effective over time.”

Since officially laying down the policy, UC has taken a hard look at its real assets portfolio, considering the general impact of macro events, according to the CIO. The investment office has also started conversations with a number of other institutions looking to take initiative and account for carbon risk in their portfolios. Now, Bachher says, the mission is leveraging that ESG lens into tangible and profitable market plays—a leap that’s stymied many an asset owner in the past.

“In the last 8 to 10 years, we have seen ESG investing gradually shift from a values-based strategy to actually creating financial value,” says Arti Prasad-Naidu, a responsible investment specialist at Australia’s Queensland Investment Corporation (QIC). “The evolution is clear: Responsible investment is moving away from just being a push from religious-based organizations screening stocks based on their ethical or moral values to now truly integrating and adding an extra layer of consideration for ESG factors. Investors now seek to make returns by doing good.”