This analysis is by Bloomberg Intelligence analysts Gregory Elders and Morgan Tarrant. It appeared first on the Bloomberg Terminal.
Sustainable investing is moving to broader investment analysis from the confines of specialty funds. Pension funds focused on long-term returns, particularly in Europe, are a main driver. Recognition of the financial cost of environmental, social and governance issues, better disclosure of company data and investor demand are among factors spurring the change. Issues such as energy efficiency, water scarcity, safety and diversity are gaining ground with a wider investor base, even without a label.
Sustainable investing finds plateaus at half of managed assets
Variously labeled as sustainable, responsible or ethical investing, the field encompasses 26% of assets under management globally, almost $23 trillion, according to the Global Sustainable Investment Alliance. Europe and Australia lead markets with about half of managed assets considering sustainability criteria, though growth appears to have leveled off (partly impacted by methodology changes). Canada and U.S. interest continues to grow, with Japan rising rapidly on government governance efforts.
Europe leads responsible assets on pension, insurance focus
European institutional investors are the most likely to scrutinize sustainability issues, with over half of managed assets considering them vs. 22% in the U.S. and less than 5% in Asia (excluding Australia), according to GSIA. Pension funds and insurance companies, given their long-term focus, have been a major driver. The preponderance of large, often state-backed, pension funds in Europe may help drive ESG uptake at asset managers. This then drives companies to more frequently voluntarily report ESG data.
Millennials sustainability investing puts money where values are
Millennials and female investors’ rising clout may boost emphasis on companies’ sustainability performance, given both demographics’ stated concerns. Of all demographics, millennials lead in terms of interest in social-impact investing (85%) and in follow-through of their concerns, with 28% making such investments, based on a U.S. Trust survey of high net-worth investors. About 25% of baby boomers and men held similar views. Millennials may outgrow those sentiments as their parents have done.
Calpers, Norges exclusion expansion may show anti-Trump effect
Ethical opinions may play a greater role for some investors amid potential policies under a Donald Trump administration that could roll back environmental and human-rights protections. Two of the largest global investors said this week that they plan to expand exclusions. Calpers will require external managers to avoid tobacco companies, despite analysis showing that it’s cost the fund $3 billion since 2001. It’s avoided in-house tobacco investing since 2000. Norges Bank added 15 coal companies to its blacklist.
Fossil fuel joins ‘sin’ stocks shows ethical investing evolution
What is deemed ethically dubious may evolve, but screening out companies engaged in unethical sectors or business practices remains at the heart of sustainable investing. Climate change concerns have driven some investors to add coal and oil producers and high-carbon utilities to the list of “sin” stocks such as tobacco, weapons manufacturers, alcohol and gambling. In addition to entire sectors, some exclude for violations in areas including human rights, severe environmental damage and corruption.
Investor engagement, resolutions are company ESG pressure points
Increased shareholder resolutions and non-public engagement by investors are pressing companies to address potentially overlooked financial risks from issues such as climate change and diversity. Majorities rarely approve resolutions, but companies increasingly acquiesce to investor demands rather than fight publicly. About 170 environment-related shareholder resolutions were filed this year vs. about 100 in 2012, according to Ceres data. Say-on-pay votes offer another engagement pressure point.
ESG scores add insight to assessing risks on data challenges
Sustainability ratings, similar to credit ratings, provide a quick and simple entry to understanding a company’s environmental, social and governance performance. Uneven company ESG data disclosure means ratings or scores can offer a view across an investable universe based on company sustainability policies and pronouncements, in addition to performance. Overall ESG scores may mask specific risks. They also often have a large-cap bias, as bigger companies can devote more to sustainability programs.
Quantifying sustainability is step to hidden financial costs
The mixed state of company ESG data reporting may provide opportunities similar to the early days of emerging markets, or other new fields marked by non-standard and uneven disclosure. Translating ESG performance into financial costs adds a further complication. Energy use is a relatively straightforward cost, but other metrics such as safety may range from cost effects to investor discount rates reflecting relative risks and uncertainty.
Patchy environmental and social data obscure business risks
Company-reported ESG information tends to be disparate and lack consistency, clouding material risks. This has spawned initiatives by some stock exchanges and outside groups to boost reporting and to define material indicators. Carbon reporting by 96% of U.K. companies in the FTSE All-World is driven by government requirements. In South Africa, 82% report under Johannesburg Stock Exchange guidelines, showing the importance of rules. Half of FTSE All-World Index constituents report carbon emissions.
Gains in sustainability tilt index may show added data edge
The MSCI USA ESG Select Index outperformed its benchmark and best-in-class ESG brethren in 2016, which may reflect the advantage of using sustainability information as an added factor to tilt an index. The index tends to overweight environmental, social and governance leaders and underweight laggards. In contrast, the MSCI USA ESG Index picks industry-leading companies, potentially giving too much weight to sustainability as a financial driver.
Low-carbon indexes lagging may worsen on carbon goal reversal
Indexes that exclude fossil-fuel extraction companies or those with high carbon emissions generally underperformed their benchmarks in 2016, as oil and gas company shares rallied. U.S. President-elect Donald Trump’s pledge to exit the Paris climate accord and roll back regulations may support high-carbon company prospects, and dim those for low-carbon solution providers. Declining renewables and low-carbon technology costs may provide longer-term low-carbon support.
Gender leadership indexes struggle to unlock diversity’s value
Indexes tracking U.S. companies that are gender diversity leaders are failing to deliver the outperformance that research shows they should provide. State Street’s Gender Diversity Index, launched in 2016, and Barclays’ Women in Leadership Index have underperformed the S&P 500 on a one-, three- and five-year total-return basis. The results may indicate that the academic research on the financial benefits of diversity may be harder to monetize than simply selecting companies with a high proportion of women leaders.