In October, in the historic setting of the Liberty Hotel in Boston, we hosted a lively discussion on a topic which is rapidly attracting attention: environmental, social and governance (ESG) investing.
Once a former prison, the Liberty Hotel provided an apt location for a dialogue in which the topic of governance was key. Built in 1851 as Charles Street Jail, the prison was ruled in 1973 to be no longer fit for purpose owing to overcrowding. However, it wasn’t until 1990 that the jail finally closed.
Turning to the topic of the day, I had two key questions for our panellists and audience to address. Did they view responsible investment simply as a passing trend or as a means to achieve superior returns? And, secondly, how could the industry help bring ESG investing into the mainstream so that it would be embraced by all investors, not just the ‘believers’.
To help answer these questions, we brought together a panel with a broad range of expertise and backgrounds, including academics, investment consultants and asset owners. This variety was similarly replicated in our audience members, who ranged from individual investors, to representatives of large institutions, demonstrating the increasingly wide relevance of ESG.
Dr David Chambers opened the discussion by presenting cutting-edge academic research into ESG investment. Most notably, he highlighted a recent global study which explored the impact that successful engagement with companies on ESG issues can have on financial returns.
Across 25,000 engagements with 5,000 global firms over the period between 1999 and 2016, the results were clear; while unsuccessful engagements did not necessarily destroy value, successful engagements showed a clear increase in positive abnormal returns.
David also provided an example of where academia meets practice, sharing with us his experience as a member of the Cambridge University working group. This was set up to look at the subject of investment responsibility, and to review the University’s statement on this topic, following calls from the student body to divest its £5.9bn endowment (the largest in the UK) from fossil fuels.
In 2016, more than 2,000 students signed a petition for divestment, and the student union council voted 33 to 1 in favour. However, the University working group strongly believed remaining invested in oil & gas companies provided the best opportunity to enact change through engagement, as divestment would leave the University powerless to make its voice heard by companies in the sector.
Dr. Chambers’ thoughts were echoed by Kate Murtagh of the Harvard Management Company (HMC). Kate explained how the HMC’s focus on sustainable investing was driven by an anti-fossil fuel movement on campus, and in 2014 led it to become the first university endowment to sign up to the UN’s Principles for Responsible Investment. As in the case of Cambridge, Harvard felt that divestment wasn’t appropriate in the context of an asset class that “you couldn’t walk away from” – after all, we are still driving cars and burning fossil fuels. Instead, the University put the emphasis on being an ‘active owner’, providing a clear mandate for the HMC to identify, monitor and manage both ESG risks and opportunities. Kate also explained the complex challenges of ESG integration across a broad range of asset classes from private equity, through real estate to the traditional public markets, and that a ‘one-size-fits-all’ analysis is not appropriate.
The importance of ‘active ownership’ was echoed by my colleague Rob Stewart. He explained our view that being an active owner (engaging and voting) is a vital part of our stewardship responsibilities to our clients, and that Newton has been doing this for over 30 years – even before our clients started to show interest in it.
Rob explained that holding companies to account is part of our responsibility not only to our clients, but also as market participants, and is essential to the proper functioning of the capitalist system.
The retirement fund perspective
While universities are facing strong demand from their students for ESG integration, Jay Roney of investment consultancy NEPC explained that, in the institutional retirement space, clients were less direct on the matter, rarely bringing up ESG in conversation explicitly. However, while they don’t specifically invest in managers that use ESG analysis, they do often see it as a part of a well-run strategy – after all, they are looking for strategies which will add value and help them reach their goal.
Jay offered three potential reasons as to why ESG is so rarely discussed by defined-benefit schemes in particular. First, with so many schemes critically underfunded, all their energies are focused on minimising risk to the organisation. Secondly, there’s the issue of education. Many of Jay’s clients confuse ESG with SRI (socially responsible investment), and see it as hindering a manager’s ability to add value by reducing the opportunity set. Finally, many individuals who sit on plan committees are performing this role as secondary to their day job, and it simply isn’t at the top of their priorities.
Jay also brought to our attention an interesting paradox – that while ESG issues may be top of the agenda in a firm’s daily activities, they aren’t always considered so important in the way it manages its pension scheme. He explained how a global company (whose own mission statement incorporated ESG goals) issued a request for proposal (RFP) in its search for an investment consultant. A large number of the questions on the RFP were ESG-related, including requests for details on the consultant’s carbon footprint and employee rights. However, Jay had never once heard this firm ask the same questions of the investments in its pension scheme.
Politics – moving forwards or backwards?
With the much-publicised news of President Trump’s withdrawal from the Paris Climate Change Agreement in mind, I put the question to James Rosebush as to how, in his rich experience of the intersection of the investment world and politics, the political landscape could affect ESG/sustainable investing today.
James was adamant that, political turmoil aside, we have very much reached the point of no return in this area, and that he did not expect politics to influence the industry to take a step back. If anything, he was hopeful about the Trump administration’s prospects for driving the topic forward, highlighting that Dina Powell, a key Trump advisor, is a leader in mission-related investing, having served as president of the Goldman Sachs Foundation, overseeing its impact investing and philanthropic initiatives globally.
Are millennials the future of ESG?
Away from politics, James also discussed the powerful role of millennials in driving ESG investment, comparing the increasing traction of ESG to a popular uprising. James highlighted how social networks have enabled people to take action and have an impact of their own accord – they’re not waiting for governments, or even the asset management industry. As such, as millennials start to get a seat at the table and call the shots, the industry has to be prepared to meet their requirements.
Jay Roney echoed the popularity of this topic among millennials, explaining that he sees a bifurcation in the institutional space between two generations. He offered the area of private wealth as an interesting example, where, particularly in the case of family offices, many of the younger members are pushing to make more impactful investments and to incorporate ESG, while the older generation is more reluctant, viewing this as detrimental to returns.
From a DC perspective, Jay explained that most millennials don’t participate in corporate pension plans, and that it’s often hard therefore for them to drive change. While those who are invested in corporate schemes could potentially make an impact by requesting managers who use ESG analysis, this is still unlikely to instigate any real change, as corporations are generally apprehensive about doing anything unique in 401k plans, owing to the risk of attracting lawsuits in today’s litigious society.
The importance of education
When we moved to the question of how the financial industry could help ESG investing enter the mainstream, increased education was the unanimous answer. A common point was made throughout the session that, very often, ESG and sustainable investing are simply misunderstood as SRI or ethical investment, and that there is much work to be done to ensure the correct definitions enter public consciousness.
More specifically, in the case of the HMC, with contentious issues such as fossil fuels evoking such passionate reactions, Kate emphasised the importance of a respectful dialogue between the University and its students in the discussion about how Harvard’s assets should best be managed, ensuring the students understand why certain decisions have been made and feel that they have had their voices heard. Rob offered the perspective of a portfolio manager, highlighting that it’s important to be clear to clients that ESG is just one factor in investment decision-making, but that it has the potential to provide the edge in making better decisions.
We would like to thank our panellists and audience members for participating in such a lively and informative discussion.
It was particularly noteworthy that, while our panellists and audience members came from such diverse backgrounds, there was consensus that interest and demand for ESG investment will only continue to grow, but that work remains to increase education and ensure best practices.
We believe this is a conversation that will continue well after this event, and look forward to being part of the debate.