What will increased momentum for social change mean for ESG investing?
In our previous blog we talked about the impact the coronavirus-driven economic slowdown has had on the environment. One consequence is that it has further raised awareness of the ways in which industrial activity affects the planet, shining a very bright light on the “E” in ESG investing.
But COVID-19 isn’t the only major event currently unfolding that is reshaping how we view our world. Demands for social justice on a scale not seen since the 1960s are also driving significant change, particularly within the U.S.
Historically, corporations generally sought to avoid controversy, and stayed out of what could be referred to as political debates. That is now much harder to do, and many companies have come to embrace an issues-oriented approach to doing business and engaging with the marketplace.
As with sustainability and environmental awareness, these ideas are increasingly getting built into corporate strategies. For the ESG investor, this provides a wealth of new insights and data, all of which can potentially allow for improved portfolio (and index) diversification across sectors and industries, more diversified holdings, and the potential for improved long-term returns.
Assuming consumers continue to pressure companies for change – and favor those brands they believe to be most closely aligned with their values – the momentum behind ESG investing will continue to grow.
The U.S. has a lot of room to run in this regard. In Europe, ESG strategies pulled in a record $132 billion in new assets in 2019. In the U.S., mutual funds and ETFs focused on sustainability saw just over $20 billion in new flows during the same period. But investor interest has been growing and that $20 billion was four times the flows from the year before. Around the world, the percentage of both retail and institutional investors that apply environmental, social, and governance (ESG) principles to at least a quarter of their portfolios jumped from 48 percent in 2017 to 75 percent in 2019, according to a study from Deloitte released earlier this year.
Which is not to say there aren’t challenges. As ESG investing has accelerated, regulatory scrutiny has picked up as well. In the US, regulations have been proposed that would require those institutional investors subject to Employee Retirement Income Security Act (ERISA), like pension funds, to demonstrate that ESG investing supports the long-term appreciation of plan assets. In other words, to show that return is not being sacrificed by adhering to ESG principles.
The reality is that ESG factors can have an impact on corporate returns, as regulators like the Department of Labor have acknowledged. Policies with regards to diversity, global warming and sustainability can present material business risks through regulatory action, litigation, loss of consumer confidence, reputational damage, and brand erosion, all potential consequences that can ultimately translate into negative market performance. But it is not enough for companies to simply point to their historic policies and concerns and expect the world to move on. People are demanding updates, answers and specifics from brands in ways never seen before, which certainly presents new business challenges but also tremendous opportunities. Viewed through this lens, the adoption of specific, actionable ESG policies can in fact confer a competitive advantage. As we noted in our last blog, embracing ESG can simply be good business.
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