ESG investing: from niche player to mainstream approach

Environmental, social, and governance (ESG) investing and ESG funds encompass a wide range of issues, from environmental concerns such as climate change and energy efficiency to social and governance issues, including gender and diversity, product safety, board composition, and executive compensation.

ESG investing in the United States was something of a niche market until the early 2000s, when investors and asset managers began to acknowledge that ESG issues had the potential to materially affect corporate performance and, in turn, investor returns over the long term. During the early days of ESG investing in the 1970s, portfolios were primarily built around exclusionary screens. Companies that engaged in questionable environmental practices or that had a detrimental impact on society—tobacco companies or weapons manufacturers, for example—were removed from a portfolio manager's investment universe.

Over the years, as ESG investing gained more of a foothold and pressure increased for corporations to be increasingly transparent about their social and environmental impact, asset managers began adding a second, positive screen to their investment processes. Rather than simply excluding companies that scored low on ESG metrics, managers were able to begin tilting portfolios in favor of companies that were performing well on ESG criteria. Many ESG investors have moved beyond portfolio construction to leverage their position as stockholders in order to influence public policy and corporate behavior.

Growth in recent years has been robust: Over the past two decades, ESG investing in the United States has grown from 55 ESG funds to more than 900, representing more than $4 trillion in assets and a diversity of approaches. While the United States has been one of the fastest-growing regions in recent years, the rest of the world has recognized the value in ESG investing for some time. In 2014, global assets dedicated to sustainable investing totaled more than $21 trillion.¹

Despite the rapid growth of ESG investing, there are a number of major misconceptions that continue to surface.

Myth #1: ESG investing is still a fringe approach

While this may have been true 20 years ago when ESG investing had attracted only $12 billion in U.S. assets, the growth of the practice in recent years has firmly established ESG investment principles in the financial industry.² In fact, in a recent survey of investment professionals, 73% of investors consider ESG factors in their investment decisions.³

Myth #2: ESG investors must sacrifice return to make positive change

ESG investing has often been stigmatized by the assumption that investors are forced to concede returns to create a positive impact. Researchers at the University of Oxford analyzed 200 studies on the sustainability practices of companies across a broad range of industries and found that 80% of the studies showed that the stock performance of companies is positively influenced by good sustainability practices, 88% of the studies showed that strong ESG performance correlates with better operating performance of companies, and 90% of the studies on the cost of capital showed that sound sustainability standards lower companies' cost of capital.⁴ Demand from individual investors also has the potential to be strong. According to one study, 86% of high net worth investors consider giving back an important or essential part of a life well lived.⁵

Myth #3: the market for ESG funds is small and insignificant

Despite the growth of the ESG marketplace over the past decade, there continues to be a misconception that the type of investor interested in ESG strategies is somehow outside the mainstream. In reality, that stereotype couldn't be further from the truth. According to US SIF, institutional investors in the United States now apply ESG criteria to investment decisions for aggregate assets of more than $4 trillion, which represents a 77% increase since 2012.²

Many professional investors are currently using ESG metrics as a means to manage portfolio risk, identify quality management teams with sustainable business practices, and, in some cases, seek to positively influence corporate behavior. We believe that investors shouldn't have to choose between being value motivated or values motivated, and ESG funds offer a compelling way to pursue both of those important goals.

1 Global Sustainable Investment Review 2014, Global Sustainable Investment Alliance, 2014.

2 “Report on US Sustainable, Responsible and Impact Investing Trends 2014,” The Forum for Sustainable and Responsible Investment, 2015.

3 “Environmental, Social and Governance Issues in Investing,” CFA Institute, October 2015.

4 “From the Stockholder to the Stakeholder: How Sustainability Can Drive Financial Outperformance,” University of Oxford, Arabesque Partners, March 2015.

5 “2015 U.S. Trust Insights on Wealth and Worth Survey,” U.S. Trust, 2015.