The following is Chris Merker's first blog posting at the CFA Institute's Enterprising Investor site: https://blogs.cfainstitute.org/investor/2017/05/29/the-stampede-into-esg/
The Stampede into ESG
As I prepared for
a recent presentation, I pulled some data from a report my firm had published
six months earlier on developments in environmental, social, and governance
(ESG) investing, socially responsible investing (SRI), and impact investing.
What I found
surprised me.
UN PRI Signatories and Their
Assets under Management (AUM)
The chart below,
taken from the same report, shows what portion of that $14 trillion is from the
United States. Note the significant jump in 2014.
US Investment Funds
Incorporating ESG Factors
The move from $1
trillion in 2012 to over $4 trillion just two years later surprised me — a 300%
change as the number of funds grew from around 650 to roughly 800. The most
recent data from 2016, which is not shown in the chart, indicates nearly $9 trillion in total assets.
The question that
struck me when I saw all this: Did all of the asset managers that are now
factoring ESG into their investment process shift all $4 trillion in assets the
day they signed up with the PRI?
The answer, of
course, is no. Nothing changed. Not really, anyway. While the move into ESG
investing demonstrates greater consciousness on the part of investment
managers, the factors themselves are “soft” in their application. As
Christopher Scott Peck, Hal Brill, and Michael Kramer observed in The Resilient Investor:
“ . . . we
recognize that the softer ESG ‘considerations’ approach, while a step in the
right direction, is less socially and environmentally impactful than SRI’s
traditionally more active approach of designing portfolios and mutual funds to
screen out the worst actors and seek out companies charting beneficial new directions.”
The stampede of
asset managers into ESG over the last four years is reminiscent of another time
and another industry.
In the 1980s, the
emergence of organic farming created an opportunity for food producers to
differentiate themselves and their products. Overnight, many farmers started
claiming their crops and livestock were “organic.” Not until nearly two
decades later, when regulators caught up and standards were put into place, did
the term “organic” start to carry real meaning for the consumer. After all,
what does it mean if chickens are “free range”? How much “range” does a chicken
need to be “free range”?
Like organic
farming 30 years ago, ESG investing today has gray areas.
The problem for
ESG asset owners and investors is how to first define their specific ESG
objectives and then audit or enforce those objectives under their given
mandate. Eliminating tobacco stocks from a portfolio is straightforward enough.
Controlling the carbon footprint of a portfolio is a different matter altogether.
Holding asset managers accountable to a given set of goals and standards is
key.
Wherever you stand
philosophically, as a practical matter, the ESG movement is here to stay. Those
who believe in the double or triple bottom line don’t think there is a conflict
between “doing well” and “doing good.” Rather, both objectives — acting
socially responsible and supporting investor goals — are not mutually
exclusive, but mutually reinforcing.
A large body of
academic research conducted over the last 30 years backs this up. In “ESG and
Financial Performance: Aggregated Evidence from more than 2000 Empirical
Studies,” Gunnar Friede, Timo Busch, and Alexander Bassen conduct a
meta-analysis of ESG studies since 1979 and conclude that 90% show statistical
evidence of a relationship between ESG factors and positive financial results.
We are a long way
from understanding what distinguishes one ESG manager from another and how we
as a society measure the effect of a given ESG portfolio. It’s like trying to
differentiate among organic farmers in 1987.
But investors,
regulators and standards will catch up.
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| Chris Merker |
Christopher K. Merker, Ph.D., CFA, is
a director with Robert W. Baird & Co. Prior to joining Baird, he ran a
successful venture capital incubator in New York's Silicon Alley. A graduate of
the University of Iowa, Merker is an MBA honors graduate from Thunderbird,
School of Global Management, and has a Ph.D. in Investment Governance and
Fiduciary Effectiveness from Marquette University. He is a past president of
the CFA Society Milwaukee and a current board member. An adjunct professor of
finance at Marquette University and a significant associate in the Applied Investment Management (AIM) program. He is also executive director of Fund
Governance Analytics, LLC, a provider of governance research and diagnostic
tools for asset owners and institutional investors.
