Morningstar Magazine - June/July 2017 - 38
Spotlight: The Future of Investing
Sustainable Investing Comes of Age
With improved data and research,
ESG enters the investment mainstream.
ESG
Jon Hale
Spurred by the global financial crisis and concerns
about climate change, sustainable investing
has experienced tremendous growth over the past
decade. Assets under management have grown
to an estimated $22.9 trillion globally, up from $3.8
trillion in 2006 ( E X H I B I T 1 ). Defined as any
investment approach that factors in environmental,
social, and corporate governance, or ESG, issues
and their impact, sustainable investing is also
benefiting from other trends. Built on the already
established foundation of socially responsible
investing, the field today is aided by moresophisticated ESG metrics, increased corporate
focus on sustainability, supportive academic
research, an organizational infrastructure, and
competitive performance.
Catalysts: Financial Crisis and Climate Change
The financial crisis was an example of excessive
risk-taking and short-term thinking. The crisis
lowered investor confidence in the financial system
and alerted investors and corporations to the
risks of systemic failure. In its aftermath, investors
became interested in focusing on hidden risks,
corporate responsibility, systemic threats, and
taking a longer-term perspective. All of these are
fundamental concerns of sustainable investing.
In the wake of the financial crisis, another
systemic threat began to attract investors'
attention: climate change. While evidence that
human-caused global warming had been
accumulating for decades, climate change burst
onto the public agenda in 2006 when former
Vice President Al Gore released the film
An Inconvenient Truth. Since then, climate
38
Morningstar June/July 2017
change has become a much bigger concern to
investors who want to better understand
the risks faced by companies, industries, and
entire economies.
Earlier this year, two of the world's largest asset
managers, BlackRock BLK and State Street
Global Advisors, announced that climate change
was their top priority in their direct engagements
with companies in which they own shares.
BlackRock wants to work with companies to use
a reporting framework developed by the Financial
Stability Board's Task Force on Climate-Related
Financial Disclosures. The framework gives
"companies and investors a starting point to assess,
report, and price climate-related risks and
opportunities," according to the board.
The field has become more sophisticated over
the past decade at addressing key ESG issues like
climate risk. Asset managers have better data
on how companies address the challenges, and
academic research suggests that attention to
these issues can reduce risk, help identify quality
companies, and enhance performance.
Institutions are emerging to provide education,
research, and platforms for ESG discussion,
and performance of ESG portfolios is competitive
with that of conventional funds and improving.
That would not be possible without data collected
by research firms such as Sustainalytics and MSCI
ESG Research.
Still something of a cottage industry in 2006, ESG
research firms covered fewer companies
and measured fewer ESG indicators. A decade
later, not only is the data more robust, it has
accumulated into a time series, making it
more useful for academic research. A recent MSCI
study (Zoltan et al. 2015) suggests that "ESG
momentum"-an improvement in a company's
ESG performance based on time series data-
is a positive factor for performance. As the ESG
research industry has consolidated, with
Sustainalytics and MSCI ESG Research becoming
the market leaders, at least seven other companies
provide ESG research today, along with upward of
100 other organizations that focus on more
specialized issue areas, according to the Global
Initiative for Sustainability Ratings. For many asset
managers, this research is a starting point
for their own ESG analysis or an input into their
evaluations of securities.
Importantly, research has also made possible the
development of sophisticated ESG indexes,
including the Morningstar Sustainability Index
Series, allowing the field to respond to demand for
passive investment vehicles.
It also has become common for companies to
publish detailed sustainability reports that focus
on ESG factors that are material to the
company's financial results. According to the
Governance and Accountability Institute, only 20%
of the companies in the S&P 500 Index issued
sustainability reports in 2011. By 2015, 81% were
publishing reports.
Academic Research
Better ESG Metrics
It is common today for asset managers to
use company-level ESG metrics in their investment
process, regardless of whether they are running
sustainable investment funds or conventional
funds. ESG data give asset managers the ability to
evaluate companies on hundreds of indicators,
to make comparisons relative to peer groups,
sectors, and regions, and to assess a company's
progress on improving its ESG performance.
Academic research on the effects of ESG on
portfolio and company performance has
proliferated over the past decade and supports
two conclusions that are positive for the field.
The first is that empirical evidence does not
support the thesis that sustainable investing
portfolios, or their antecedents that focused on
exclusionary screening, underperform
conventional portfolios. Most earlier research
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