November 12, 2020

Expect an Increased Tempo for ESG Investing Post-2020

A pandemic and calls for racial equity have only accelerated sustainable investments, and shaped the agenda for next year.

Reported by Sarah Min

A shift is occurring in the capital markets. Despite some opposition, more institutional investors are throwing their weight behind sustainable investments than ever before.

This comes at a time when the coronavirus pandemic and calls for racial equity have spurred allocators to consider a wider group of stakeholders in their portfolios.

And those trends are expected to accelerate next year, as a Biden administration should be more amenable to sustainable investments. The president-elect has already pledged to rejoin the Paris Climate Agreement and made renewable infrastructure a focal point in his campaign. Furthermore, advocates of environmental, social, and governance (ESG) investing can expect better standards and disclosures around diversity and inclusion factors at companies.

The volume of assets under ESG investing strategies is growing, as well. In 2019, the number of sustainable funds jumped to about 300 open-ended and exchange-traded funds (ETFs), up from 270 the year prior, according to data from Morningstar.

“The interest in ESG, I would argue at this point, is really unstoppable,” said Don Calcagni, chief investment officer at Mercer Advisors.

Racial Equity Becomes a Much Bigger Issue

Many institutional investors expected the ESG conversation this year to center solely on climate change. But then the deaths of George Floyd, Ahmaud Arbery, and others blew open the ongoing fight around racial equity.

Black Lives Matter considerations are increasingly important to corporations. In June, Facebook lost about $60 billion over a two-day stretch in market value after a number of firms, including Coca-Cola and Starbucks, pulled ads from the social media giant protesting the spread of hateful content on the platform.

Meanwhile, in the past five months alone, about 130 Black members have been appointed to boards at Russell 3000 companies, up from just 38 in the five months prior to Floyd’s death, according to a Barron’s report that cited BoardProspects.

The issue is not limited to the United States. The Black Lives Matter movement has also pushed the conversation on racial justice in the investment community elsewhere in the world. In Australia, after mining conglomerate Rio Tinto blasted through caves at a 46,000-year-old heritage site in the Juukan Gorge that belonged to Aboriginal landowners, stakeholders ousted the firm’s CEO, Jean-Sébastien Jacques, as well as other top executives.

Last week, an investor group representing $14 trillion in assets that included Fidelity and the Church of England Pensions Board demanded Rio Tinto assure them how the company will maintain a relationship with the Aboriginal First Nations people.

“This is a matter about how laws have oppressed people, and continue to oppress people and destroy cultural heritage and violate human rights, and that all exists in that context of colonization in this country,” said Brynn O’Brien, executive director at Australasian Centre for Corporate Responsibility (ACCR). “So, the Black Lives Matter protests in the United States have spread out all across the world.”

The increased prominence of racial justice has propelled companies to re-think setting workplace ESG standards. Take the Sustainability Accounting Standards Board (SASB), a global body supported by 170 institutional investors holding roughly $55 trillion in assets. The group is busily working on a new initiative called the Human Capital project.

While the research project started last year, researchers said the protests in 2020 have added urgency to their work exploring emerging issues for workers and worker relations—such as how issues of diversity and inclusion are incorporated across the 77 industries SASB covers.

“Our understanding of them and the importance of them for investors have been accelerated this year,” said Neil Stewart, director of corporate outreach at SASB.

Diversity considerations will also continue to impact investments beyond public equity markets, where investors have fewer tools with which to engage with firms. In the private equity sector, investors who have greater influence over portfolio companies can dictate the diversity and inclusion mandates of board composition, for example.

“That’s a big difference,” said Nathan Shetty, head of multi-asset portfolio management at Nuveen.

The Human Capital project also explores other factors, such as worker health and safety, which has become as material to financial services companies as a result of the pandemic as it has traditionally been in the manufacturing or oil and gas sectors.

Apart from the Human Capital project, other industry-specific issues are being explored for standard-setting, including tailings management for mining companies or replacements for plastics.

Core Opposition

In recent times, ESG investing has faced obstacles. Under the Trump administration, the Department of Labor (DOL) has sought to curtail the use of ESG strategies in employer-sponsored plans, which is expected to have a chilling effect on public pension funds.

Meanwhile, some academics have taken a skeptical view of ESG approaches. A recent study from the Massachusetts Institute of Technology (MIT) Sloan Sustainability Initiative, for instance, argued that ESG performance ratings are too “vague and inconsistent” to use. Another report from the Organization for Economic Co-operation and Development (OECD) said ESG performance is mixed.

Meanwhile, researchers from the Center for Retirement Research at Boston College (CRR) concluded in a recent report that social investing is “not appropriate” for public pension plans. The study found that the strategies do not improve financial returns for investors, mainly because the fees of ESG funds compared with Vanguard funds were generally 80 basis points (bps) higher. Researchers also said early social investors in past decades have lost money on ventures.

However, proponents of ESG clarify that early “social investors” often used divestment as their main ESG strategy, while newer methods seek to keep the holdings. Now, shareholder activists seek to guide companies to alter behavior, arguing that addressing ESG concerns will bring a better and more lucrative future than divesting.

Other reports found that ESG investments routinely beat traditional markets. A June report from Bank of America found that ESG stocks outperformed traditional stocks by 5 to 10 percentage points during the virus-induced market downturn. A Harvard report similarly found ESG funds do better during market slides, as well as over the long term.

Another report from the CFA Institute found that a portfolio consisting of S&P 500 companies that score highly on ESG criteria outpaces another consisting of S&P 500 companies that score poorly on ESG criteria. The ESG portfolio did better by 16 basis points. Meanwhile, Morningstar found a slightly higher cost for ESG investing if investors only invest in US and Canada holdings, but once the investment horizon expands to include other nations, there’s no difference in cost.

Even Securities and Exchange Commission (SEC) Commissioner Allison Herren Lee, who was appointed by President Donald Trump, wrote in a New York Times op-ed that, despite the current administration’s rollback of environmental rules, many companies are bent on meeting ESG criteria anyway.

European Rules

Meanwhile, countries elsewhere in the world are enforcing stricter ESG regulations that could still affect American investors. In Europe, a new disclosure framework called the Sustainable Finance Disclosure Regulation (SFDR) will require investors to gather data on ESG risks across all funds in their portfolio, not just ESG strategies, starting in March.

American asset managers who have any funds registered for marketing in the European Union will have to update fund disclosures by the March deadline next year.

“It’s super, super broad,” Lucian Firth, partner at law firm Simmons & Simmons, said at a recent webinar.

ESG commitments have made greater strides in the European Union, where adherence to the Paris Agreement has driven greater amounts of private capital to sustainable solutions. This year, 89% of institutional investors are considering ESG investments, up from 55% last year, according to a report this week from Mercer. The report studied more than 900 institutional investors that collectively hold more than $1.3 trillion in assets.

Aiding those efforts is an increased push to find a unified set of ESG standards ahead of any regulatory changes. Some companies have complained that varying lists of standards have left them confused. In September, a group of five sustainability leaders—CDP (formerly the Carbon Disclosure Project), the Climate Disclosure Standards Board (CDSB), the Global Reporting Initiative (GRI), the International Integrated Reporting Council (IIRC), and the SASB—said they would work together to develop a common framework for corporate ESG reporting.

“Existing standards and frameworks are building blocks in a global comprehensive corporate reporting system,” SASB’s Stewart said.

For a lot of institutional investors, one thing is clear: Despite the problems, ESG investing is here to stay.