Understanding ESG Investing

Over the past several years, environmental, social and governance (ESG) investing has garnered considerable media attention and increased interest among investors. But many people are still not exactly sure what ESG investing constitutes, while many skeptics continue to believe that focusing on any noneconomic attributes of a company can hinder performance.

What Is ESG?
ESG investing is a type of “sustainable investing,” which is an umbrella term for investments that, while seeking positive returns, also consider the long-term impact that business practices have on society, the environment and the performance of the business itself (Exhibit 1).

According to the US SIF Foundation, of the $40.3 trillion of total assets under professional management in the United States in 2016, $8.1 trillion is invested in ESG portfolios (Exhibit 2). That represents a 30% growth rate from 2014, when such assets totaled $6.57 trillion.¹

Of these assets, $5.38 trillion is allocated among separate accounts and other nonspecific vehicles primarily serving institutional investors. While the retail market is relatively small, it is also experiencing a rapid growth rate. In 2016, the total ESG assets of investment funds (mutual funds, variable annuities, ETFs, closed-end funds, alternatives) and other listed pooled products rose to $2.6 trillion, which is more than double the $1.01 trillion that was tracked in 2012, and more than 10 times above the $202 billion of ESG assets that were held in 2007. The 475 mutual funds account for both the largest number of ESG funds and the greatest share of retail ESG fund assets under management at $1.72 trillion (Exhibit 3).

 

 

Why Is ESG Investing Generating So Much Interest?
Several factors are driving increased interest in ESG investing.

Millennial Investors and Women Have a Particular Interest in Sustainable Investing
A number of studies have shown that millennials (particularly affluent millennials) and women have a strong interest in sustainable investing.

• 90% of affluent millennials—versus 76% of wealthy nonmillennials—said they were interested in realizing competitive returns from their investments while also promoting positive social and environmental outcomes, according to a 2015 survey conducted by TIAA.
• 84% of ultra high net worth millennials expressed interest in SRI and impact investing, and 76% expressed interest in ESG investing, in a survey conducted in 2015 by OppenheimerFunds and Campden Research.
• Women are twice as likely as men to consider investments that both deliver positive returns and make a positive impact, according to a 2014 survey conducted by Morgan Stanley.

This level of interest is particularly important given that $30 trillion in wealth will be transferred from baby boomers to their heirs, including the 90 million millennials, over the next several decades,² while women will control 66% of the consumer wealth in the United States in the next 10 years.³

ESG Investing Is Being Recognized by Government and Industry Organizations
In the past few years, government and industry organizations have also changed their views toward ESG investing in ways that will greatly contribute to the growing interest in this approach to investing.

• The U.S. Department of Labor issued guidance about ESG considerations that opened the door for retirement plans to adopt ESG policies and strategies for their investment platforms,⁴ while other countries are requiring their pension plans to disclose whether ESG data are incorporated into their investment funds’ policies and procedures.⁵
• In 2006, the United Nations launched its Principles for Responsible Investment (PRI) to work with investors, asset managers and policymakers to promote international awareness of fiduciary responsibility and sustainable investing. As of April 2016, the PRI base included 1,500 signatories representing $62 trillion in assets under management.⁶
• In 2016, the well-known fund rating service, Morningstar, introduced its Sustainability Rating^TM for mutual funds, to help investors gauge how well the companies in a fund’s portfolio are managing ESG factors.