Last year was a tough one for the equity and bond market overall. Except for funds that use environmental, social, and governance (ESG) considerations as a meaningful part of the fund’s strategy. In this article, FRA talks to three of the scheduled speakers at the Sub-Advised Funds Forum in April about ESG strategies, the factors driving the interest in these investments, and what the future holds for them.
2018 was a dismal year for stock market and bond market returns. But there was one bright spot in the overall U.S. fund universe, according to Morningstar’s recent Sustainable Funds U.S. Landscape Report. Sustainable funds had record net flows of $5.5 billion, the third consecutive year of record flows. Assets under management in the subset—including funds that have converted to ESG strategies—reached $161 billion, Morningstar reports.
Sustainable investing uses environmental, social, and governance (ESG) criteria to evaluate investments. The approach can be said to go back more than 20 years, with roots in what was commonly known as socially responsible investing (SRI) or more broadly as value-based investing. Those investments were more exclusionary and would often screen out “sin stocks,” such as companies in the alcohol, tobacco, firearms, nuclear power or gambling businesses.
Over time the language and implementation strategy has evolved. While exclusionary strategies still exist, there are now non-exclusionary strategies to consider, such as best-in-class, ESG integration, and impact investing. These strategies may focus on finding opportunities with companies that manage environmental and social issues effectively and have strong corporate governance practices, essentially managing their businesses for long-term sustainability.
Morningstar has been paying attention to ESG for years, according to Peter Di Teresa, head of manager selection, Morningstar Research Services LLC, and one of the panelists who will discuss ESG investing at The 27th Sub-Advised Funds Forum, April 10-11 at the Princeton Club in New York City. The investment strategy is gaining more traction and these funds, particularly equity funds, have done better in what otherwise has been a difficult market, he says.
Leslie Samuelrich, president of Green Century Capital Management in Boston, who is also a panelist at the Sub-Advised Funds Forum, says it’s important that financial advisers pay attention to the investment strategy. “It’s not a fluke or a blip. It’s a growing trend that is here to stay,” she says.
Marla Skeffington, a retirement strategist formerly with Natixis Investment Managers, who will moderate the panel, agrees that the investment industry is moving in the direction of ESG. Part of the reason, she says, is the millennial generation is demanding it and they will represent 25 percent of the global workforce by 2025. The millennials, many of whom are burdened by student debt, value financial stability and are contributing to their retirement funds earlier in their careers.
“When you look at the demographic shift and transfer of wealth, it is a perfect storm of how attitudes are changing in how they are investing,” says Skeffington, noting that the millennials want to invest in companies that align with their values so it’s important that they have viable ESG investment options.
The good news is there are a lot more companies that have full-blown sustainable programs and social corporate responsibility programs, says Skeffington. In 2011, only 20 percent of companies published corporate sustainability reports. But that number skyrocketed to 81 percent in 2015, she says. “Clearly more and more companies are reporting on this and investors are requesting it,” she says.
And the number of sustainable funds is also growing. In 2017 Morningstar identified 235 sustainable funds. By 2018, that number increased to 351. That list includes 37 newly launched funds, the report said, and 63 existing funds that added ESG criteria to their prospectuses for the first time.
These funds are grouped into four types, according to the report: Funds that consider ESG alongside many other factors; funds that fully integrate ESG/sustainability criteria in all facets of their process; funds that aim to deliver societal or environmental impact alongside financial return; and funds that focus on areas of the market that reflect the green economy.
Stumbling blocks and opportunities
One of the challenges, however, is that there is no universal terminology for these investments. Firms or fund companies may not define ESG or sustainable investing in the same way and may have different criteria to determine which securities are right for their strategy. It can become very complicated, says Di Teresa. But that isn’t a reason to walk away from these funds.
“Don’t let your quest for the perfect turn you away from the good in ESG investing. The perfect fund may not be out there but that doesn’t mean your investments won’t make an impact. I’d argue that participating is better than not participating,” says Di Teresa, noting that investor money can influence a good company to become a better one.
Samuelrich urges advisers to learn more about these types of investments to add to their books of portfolio offerings. Advisers who take the time to research different ESG and SRI offerings will be in a better position to retain their clients and even attract new ones. “There is a growing population looking for advisers who have information around this,” she says.
But that means doing more than relying on screens to find the companies that have the best ESG ratings. The ESG screens will provide one aspect of value-aligned investments. But advisers need to “look under the hood at the actual holdings,” Samuelrich says, to determine how the firm or mutual fund uses ESG factors. “It’s easy to slap the word ‘green” or ‘sustainable” at the front of a fund’s name, but it doesn’t necessarily mean it’s sustainable. It may be just a marketing tactic,” she says.
Editor’s note: Di Teresa, Samuelrich, and Skeffington will join Naomi English, executive director, ESG Solutions, and Sandra Ackerman-Schaufler, head of international and emerging markets equity and senior portfolio manager, SEI Investments Management Corporation, in the panel discussion on ESG on April 11, the second day of the The 27th Sub-Advised Funds Forum, Click here to see the full agenda and registration information.