Some in our industry believe that applying an ethical or socially responsible overlay to investments means giving up some returns.
This view is reinforced by the language often used to describe the end result – companies are ‘excluded’, portfolios ‘divested’ and investors are applauded for having ‘taken a stand’ – all seemingly at the expense of returns.
In reality, there is a significant body of evidence that suggests integrating environmental, social and governance (ESG) into the investment selection process can in fact have a positive, rather than detrimental, impact on returns.
The clear reality is that ESG factors have a significant impact on how an investment performs – knowing everything that’s under the bonnet of companies you invest in is becoming not just helpful but essential when making an investment decision.
Simply put, many investors are beginning to realise the old argument – that responsible investing equals lower returns – is at best misguided and at worst completely misleading.
It could be argued that ignoring how a company is governed and its impact on the environment and society is as blinkered as buying shares without assessing a company’s books.
This is indeed at the heart of a trustee’s fiduciary duties and is being supported by regulators and other institutions.
In the UK, for example, the Law Commission last year recommended that “financially material ESG issues should be taken into account by trustees” – acknowledging the very real impact these factors can have on returns over time.
Integrating ESG into the investment decision-making process provides a lens beyond traditional financial metrics.
There are other considerations too, which are pulling ESG into the mainstream.
One of these influences is that most demanding of generations – the millennial generation. This generation expects its superannuation fund to be as responsibly sourced as its coffee.
Millennial investors also want to know their money is not contributing to climate change or preventing the education of children, for example. At the very least, they want to know that those with a fiduciary duty to look after their money have taken ESG factors into account and are making investments with their eyes fully open.
Some may even demand their money be put to use in companies which contribute positively to society, adding not just dollars to their retirement, but at the same time helping to shape a better world.
The critical gaze of the millennial generation has already fallen on many corners of business. Take Johnson & Johnson (J&J), which has for years relied on its baby care products as a perennial cash cow, with a steady stream of new parents adding its ‘no more tears’ shampoo to shopping baskets. Not so the millennial generation.
Millennials are shunning these former staples in exchange for more expensive organic alternatives – J&J’s first quarter results this year showed sales of its baby care range had fallen 14 per cent to $95 million, their lowest level in a decade. The company is currently relaunching its baby care range.
Understanding the shifting sands of consumer behaviour is of course difficult and not necessarily the job of a pension trustee or other institutional investor – but what examples like these emphasise is that there is a very real change, not just in attitude, but in behaviour too – one which people are increasingly prepared to back with their wallet.
The convergence of regulatory and societal pressures, combined with mounting evidence in favour of the benefits of embracing ESG as serious investment risk factors, suggests time is not on the side of those who continue to ignore it.
For custodians, this means providing investors with the tools they need to understand ESG and to be able to integrate it into their investment process – if not directly, then by challenging those who manage assets on their behalf.
For super funds it means understanding ESG and being proactive in introducing it into the investment process.
Dietmar Roessler is global head of segment for asset owners at BNP Paribas Securities Services.
