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The Rise Of ESG Investing



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Protests broke out across the country following George

Floyd's death in Minnesota, after a police officer there

knelt on his neck for eight minutes and forty-six seconds.

As the Black Lives Matter movement brought thousands upon

thousands into the street, company after company tried to

showed their support on social media.

They blacked out Instagram and condemned police brutality

and racial injustice.

Consumers and activists soon called them out with their own

social media campaigns with hashtags #openyourpurse and

#pullupandshutup. And some companies did.

They announced big initiatives with big price tags.

Bank of America announced a one billion dollar plan to

assist communities of color impacted by the coronavirus

pandemic. Cisco donated five million dollars to a number of

organizations fighting racism.

Millennial makeup company Glossier pledged a one million

dollar donation to organizations and Black-owned beauty

businesses. Nike committed 40 million dollars to the Black

community over the next four years.

Nike, though, soon faced criticism for a lack of diversity

among its executive ranks.

Before the death of George Floyd —and before Covid-19 forced

corporate America into lockdown— companies were being

singled out on the basis of corporate responsibility,

either for a lack of it or for a commitment to progressive

ideals. It's a trend that began to accelerate well before

the current demonstrations and pandemics.

It's just now gone mainstream.

So it's gone from something that is looking at policies and

procedures to something that is looking at real-time

behavior as it plays out in front of us.

This all falls under what's known as ESG investing, which

stands for environmental, social and governance.

It's a catch-all term for socially responsible investing.

Here's how ESG investing could change Wall Street and the

business world.

Environmental, social and governance.

Socially responsible investing.

Impact investing, A lot of terms come up when we think of

ESG investing and it can get confusing.

So we're going to let the experts define it for you.

Well, the way we think about it at Bank of America is, it

basically boils down to environmental, social and

governance considerations that are part of the panoply

of considerations that we as investors consider when buying

and selling securities.

ESG at the level of corporate essentially reflects

companies' attempts to integrate environmental and social

issues into the way they do business, into their business

model and into their strategy.

So a quick recap. E stands for environmental.

S stands for social.

G stands for governance.

ESG investing means taking into consideration how a

company's environmental, social and governance performance

will affect a company's financial performance and in turn,

use that to determine investing in the company.

According to a Morningstar Direct report, a record $45.6

billion went into the global sustainable fund universe in

the first quarter of 2020.

Interest in sustainable investing jumped to 85 percent in

2019, up from 71 percent in 2015.

Bank of America predicts the money in ESG investing could

rise to between 15 and 20 trillion dollars because of

changing demographics.

ESG investing has its origins in a 2004 letter from former

United Nations Secretary-General Kofi Annan.

He wrote to 55 CEOs of the world's leading financial

institutions, inviting them to participate in an initiative

that would bridge the gap between investors and important

environmental, social and governance issues.

The group formed into what is known today as the Principles

for Responsible Investments.

Members are required to report their responsible investment

activities each year.

More than 2,000 money managers like BlackRock, Morgan

Stanley and JPMorgan have signed on.

ESG had made its mark, but it still wasn't widely adopted

by investors. Flash forward 16 years to January 2020.

The CEO of the world's largest money manager, BlackRock,

released a letter to its investors that stunned Wall

Street. BlackRock CEO Larry Fink told other chief

executives that climate change and investment decisions

surrounding it would lead to a fundamental reshaping of

finance. Fink wrote, "As a fiduciary, our responsibility is

to help clients navigate this transition.

Our investment conviction is that— sustainability and

climate-integrated portfolios can provide better

risk-adjusted returns to investors.

And with the impact of sustainability on investment returns

increasing, we believe that sustainable investing is the

strongest foundation for client portfolios going forward.

Suddenly, every Wall Street CEO wanted to discuss how they

were making profit and doing good at the same time.

Sustainable investing can be confusing for some investors.

For example, you can invest in funds or companies that

avoid the tobacco, arms and fossil fuel industries.

You can also target investment toward companies that do

good, like workplace equality or reducing carbon emissions.

Those are just a few ESG strategies.

Investors used to think that socially responsible investing

would eat into a company's profit and competitive

advantage. Now investors see it as an opportunity to

identify potential risks or even disasters before they

happen. The biggest ESG criticism has been that some

companies use it as a marketing ploy.

These are useful statements.

It's great marketing.

But again, it's a lot of sizzle, no steak.

Companies make grand promises to become more inclusive or

environmentally friendly, which opens them up to more ESG

money and improves their public standing.

But some companies don't end up following through on those

promises. One early example?

Volkswagen's emissions scandal.

Volkswagon's Emissions emissions scandal keeps shares in the

red. People were duped into believing they were buying a

green vehicle that was not green.

Fines and settlements that Volkswagen has paid up to 20

billion dollars, one of the most costly corporate scandals

in history. It's essentially about maintaining business as

usual, but trying to tell a story or a narrative

that exaggerates, let's say, your environmental

and social commitments or initiatives.

There's been also a number of of real cases

where a company had accident, if you want,

that, you know, the ESG ratings provider

anticipated in a sense.

And that has helped getting more recognition.

So Equifax is a case where,

you know, that particular company had a fairly major hack

problem with data privacy and security.

And as an example, we downgraded Equifax a year before the

hack to the lowest level of our rating on the basis of

them having already had a relatively bad track record

of managing their data security.

And on the fact that the company in that sector should

actually have fairly robust practices in this area.

The practice of greenwashing has forced Wall Street to

scrutinize companies.

The skepticism around ESG investing is warranted.

There are companies that disclose information just for the

sake of disclosing.

And so far, there hasn't been a lot of accountability in

terms of stated goals versus progress towards the

goals. How do you differentiate as an investor between a

company that's talking the talk and a company that's

walking the walk? And here what we think we need to do is

start tracking companies achievements of the goals that

they're stating in their corporate sustainability reports,

et cetera. And that's one of the critical differentiating

features when it comes to analyzing companies.

In Europe, laws mandate that public companies, asset

managers and pension funds must disclose environmental,

social and governance risks in their investments.

The U.S. doesn't have the same level of transparency.

In the last 10 years, more companies in the U.S.

have begun to self-report their ESG performance along with

their financial statements each year.

Research firms, investors and other stakeholders take the

self-reporting data and other public information to rate

the company based on a range of ESG data.

Criteria can range from how they treat their employees to

how sustainable their corporate culture is or how diverse

their board is. Even if a company receives a high ESG

ranking, it doesn't guarantee that the company will be

profitable in the long term.

We know from research that companies that do genuinely

understand and integrate these issues, not more

box-ticking, not greenwashing, but actually integrating.

In the long run, they are better-performing companies,

especially those that identify and improve on the

financially material issues of their industry.

One of the things that we have found is that depending on

the model that you're using, you might be getting very

different estimates.

So what what do you do if a company, for example, is not

reporting its gender diversity in the employee

workforce or what do you do if a company is not reporting

greenhouse gas emissions?

Or what do you do if a company is not reporting lost time

injury rates in the workforce?

You try to estimate that.

So far there is no single standard in place for ESG tracking

that companies can all follow.

Research firms like MSCI have been trying to help quantify

the data and help investors make informative decisions.

The firm has more than 1,000 MSCI ESG indexes and provides

ESG ratings for around 8,500 companies.

The ESG rating itself we look at different types of issue,

depending on where the company is operating,

so that the nature of their business.

So if you take a mining company issues about, you know, the

environmental footprint, hats and safety would be

consideration that we would look at.

In the technology sector, it would be more examples around

data privacy and security.

If we look at the retailer, we would look at the supply

chain and how this retailer is managing their supply chain.

So there's a range of issues, or roughly 30 of them

that we monitor.

Over the past year, the iShares ESG MSCI USA

ETF, one of the most popular ESG ETFs, has outperformed the

S&P 500 by more than four percent as of June

22,2020.

ESG investing is becoming a bigger concern outside of Wall

Street boardrooms.

87 percent of millennials and 64 percent of women agree

that ESG plays an important role in their investment

decisions. There are three groups that show up as being

most interested in ESG.

It's millennials, women and high net worth individuals.

So essentially, millennials are the folks that are going to

inherit and generate wealth over the next couple of

decades. Women are increasingly heads of households and are

making investment decisions for their households.

And then high net worth individuals are the folks that

control the largest proportion of assets today.

So just millennials alone stand to inherit or create wealth

in the U.S. of about 80 trillion dollars over the next

couple of decades.

You just took that and you took a quarter of it, a fairly

conservative allocation, 20 trillion dollars is effectively

the size of the S&P 500 today.

And that's a proportion of assets that could potentially

flow into ESG and impact investing over the next couple of

decades. The recent calls for further transparency from

companies on their diversity inclusion efforts has

reinvigorated interest from the everyday consumer.

As corporate executives respond to the current crisis

around racial inequality and civil rights,

I think that they are implementing a wide range of

approaches. Some of that involves corporate philanthropy.

But I tend to focus more on what's happening inside the

enterprise as well as what's happening at the board level.

That's really where the rubber meets the road.

And that's really where corporate leaders actually have the

most influence, if you will, within their own

organizations. And so if they can't stand on the policies

and practices of their own organizations, I don't think

they really have the credibility, right, to use

philanthropy as a substitute for getting diversity and

inclusion and human capital management strategies right

within their own organizations.

You've got to do that first. Think about it.

If you have a consumer company that sells primarily to

women, but the board of directors is dominated by men,

there's a disconnect between the management team and the

decisions being made at the top versus who's actually

buying the products.

And this has actually been a very strong signal of weaker

return on equity for companies that have a lack of

diversity in their management and board of directors.

Similarly, for social aspects like employee satisfaction,

if you have a company within a competitive landscape, your

number one asset is your skilled workforce.

If your workforce is dissatisfied and likely to leave and

go to a competitor, that's a risk to your bottom line and

to your existential characteristics in the marketplace.

The disconnect between Wall Street and Main Street has grown

more and more stark, especially with the global pandemic

and demonstrations over racial injustice rocking America.

As millions lost their jobs and thousands took to the

streets in protest, the stock market surged.

But there's one silver lining.

ESG investing is also set to surge in 2020.

While the market was quite volatile, what was very

interesting is that investors were really flocking to

ESG strategies.

As early as six months ago, the focus was squarely on the

'E', right, and specifically on climate change and the

investment implications of climate change.

I think what has happened in the last six months because

of the Covid-19 crisis and because of

the issues around racial inequality in the U.S.

and the ensuing global protests that have evolved,

there's been a big focus on 'S' and social issues as it

relates to labor, as it relates to employee safety,

as it relates to the supply chain.

A whole host of issues that were, I would say, not as much

of a focus are absolutely front and center.

I would expect that ESG would be a standard option as

opposed to one that you need to ask for, you know, if your

clients of a mutual fund or a wealth management

organization. And the second element is full transparency

on the ESG characteristics of funds so that as an

investor, you feel comfortable that you know what you're

buying in terms of ESG characteristics.

In 10 years, this will probably be much more embedded in the

investment process.

ESG investing won't be some carve out of the investment

panoply, but every investor in the world will be armed with

these new tools and these new data sets that will help them

to make more informed investment decisions.