Understanding ESG Investing

March 01, 2017

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).

 

Understanding ESG Investing

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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 RatingTM for mutual funds, to help investors gauge how well the companies in a fund’s portfolio are managing ESG factors.

 

Understanding ESG Investing

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Understanding ESG Investing

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Can Focusing On ESG Factors Deliver Investment Benefits?
Despite lingering skepticism, a wealth of research suggests that ESG-focused practices can enhance, not hinder, investment returns (Exhibit 4).

Deutsche Bank examined 2,200 studies of sustainable investing and found positive correlations between strong ESG practices and corporate financial performance for companies in every region of the world. Those positive correlations held up across all the asset classes it examined—equities, bonds and REITs.

The University of Oxford also conducted a comprehensive study that combined the findings of 200 empirical ESG studies. The researchers concluded that companies with robust sustainability practices demonstrate better operational performance, and the beneficial impact of these practices was found to be stable over time. The research also showed that diligent sustainability practices have a positive influence on investment performance.7

The findings were as follows:

  • 90% of the studies on the cost of capital showed that sound sustainability standards lower the cost of capital of companies.
  • 88% of the research showed that solid ESG practices result in better operational performance of firms, which ultimately translates into cash flows.
  • 80% of the studies showed that stock price performance of companies is positively influenced by good sustainability practices.

In addition to stronger historical performance, companies with strong ESG practices have also exhibited lower risks. In an examination of mutual funds, Morningstar found a statistically significant relationship between funds with higher sustainability ratings and lower volatility.8

How Are Companies’ ESG Practices Evaluated?
It’s been said that sustainable investing isn’t only about changing the world, it’s about understanding how the world is changing. For investors to determine which companies are best equipped to handle—and even potentially help resolve—the many global challenges we face today, it has become essential to have an effective way to evaluate their ESG practices.

The firms that evaluate companies’ ESG practices examine a broad range of issues and consider how prepared companies are to handle an ESG risk, how transparent they are in disclosing ESG-related issues, and how well they managed the risks involved in any ESG controversies or incidences. The analysis is both quantitative and qualitative, drawing on specific data points and analysts’ informed judgments.

Environmental
ESG evaluators look at environmental issues like a firm’s carbon intensity, which is a measure of the greenhouse gases a company emits from its business practices, in relation to its revenue. They also examine how a company sources its raw materials, how much waste it produces in its operations, how it disposes of that waste and whether its product packaging is disposable. A company can increase its score if it makes positive ESG contributions with initiatives such as the use of clean technology or the construction of green buildings.

Social
Companies’ labor management practices are assessed, as are the measures they take to ensure the health and safety of their workers. ESG analysts also take into account the labor practices of the suppliers that companies use.

 

Understanding ESG Investing

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The impact that companies’ products and services has on their customers matters as well. Companies that make low-quality products that put their customers at risk would have low social scores, while companies engaged in positive initiatives, such as delivering products that help improve nutrition for low-income populations or enhance health care for consumers in underserved regions, would receive high social scores.

Governance
ESG evaluations also look at how well a company manages itself. Executive compensation is a key consideration, particularly with respect to where executive compensation falls relative to the company’s industry, with lower scores given to firms whose executive compensation is excessive. A history of engagement in corrupt practices will bring down a governance score, while strong safeguards to support and encourage business ethics will raise a score. The rights of shareholders, and the protections provided for the interests of minority shareholders, are key considerations as well.

An Opportunity To Align Values With Financial Goals
The scale of the global environmental and social crises that call for better ESG practices at companies, the growing interest in these issues among investors, the increasingly rich ESG data and the evidence that suggests ESG focused portfolios can deliver enhanced risk-adjusted returns all lead to the same conclusion: ESG investing is here to stay and offers investors a way to align their personal values with their financial goals.

 

Learn more about long-term strategies at OppenheimerFunds.


1. Source: US SIF Foundation’s Overview of Sustainable, Responsible and Impact Investing in 2016, available at http://www.ussif.org/content.asp?contentid=40.
2. Source: Accenture: The “Greater” Wealth Transfer: Capitalizing on the Intergenerational Shift in Wealth, 2016.
3. Source: Fleishman Hillard Inc., a public relations and marketing agency based in St. Louis.
4. Source: CalPERS Adopts Environmental, Social, and Governance Strategic Plan, www.calpers.ca.gov, as of Aug. 15, 2016. State Comptroller DiNapoli Positions New York Pension Fund For Low Carbon Future, http://www.osc.state.ny.us, as of Dec. 4, 2015. Long Term Stewardship: A Pragmatic Approach for ESG Integration for Institutional Investment, North Carolina Department of the State Treasurer, as of Sept. 21, 2016.
5. Source: Pensions & Investments, Jan. 19, 2015.
6. Source: Unpri.org, as of April 2016.
7. Source: “From the Stockholder to the Stakeholder: How Sustainability Can Drive Financial Outperformance,” University of Oxford and Arabesque Partners, September 2014.
8. Source: Higher Sustainability Ratings Can Mean Lower Risk. Morningstar, as of Oct. 13, 2016.

Carefully consider fund investment objectives, risks, charges and expenses. Visit oppenheimerfunds.com or call your advisor for a prospectus with this and other fund information. Read it carefully before investing.

The alternate revenue weighting approach employed by the Funds, while designed to enhance potential returns, may not produce the desired results. The stocks of companies with favorable ESG practices may underperform the stock market as a whole.

These views represent the opinions of OppenheimerFunds Inc. and are not intended as investment advice or to predict or depict the performance of any investment. These views are as of the publication date, and are subject to change based on subsequent developments.

OppenheimerFunds is not affiliated with ETF.com.
© 2017 OppenheimerFunds Distributor, Inc.
Oppenheimer funds are distributed by OppenheimerFunds Distributor Inc.
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