Michael Allison, Equity Portfolio Manager at Eaton Vance says that the desire to impact positive social change has resulted in investment inflows to the ESG category. He writes:
Socially responsible investing (SRI) has come a long way in the past few decades. Initially, SRIs were largely used as a means to avoid controversial sectors, such as weapons, alcohol, tobacco, animal testing, abortion, coal or oil. SRI investing earned a stigma – deserved or not – of delivering suboptimal investment returns due to complete avoidance of some industries.
About a decade ago, if an investor expressed a concern about climate change, the course of action was often negative screening of carbon-intensive investments like coal and oil companies. The result was a fund that was typically less diversified than its non-SRI counterpart, and these funds tended to underperform the broader market.
There has been a shift in the posture of SRI investment strategies recently. Rather than using SRIs as a means to avoid sectors, investors are now more commonly using them to support companies that align with their beliefs. Once a primarily exclusionary method of investing, these inclusionary portfolios are generally referred to as environmental, social and governance (ESG) investments. Today, the most popular ESG investments are “green” funds, which prioritize companies that are environmentally friendly relative to their peers. Another common ESG focus is on companies that promote gender equality.
The desire to impact positive social change has resulted in investment inflows to the ESG category. According to a poll conducted last year by Morgan Stanley, over 70% of all investors surveyed said they were interested in sustainable investing. In the increasingly important millennial category, that proportion was 84%.
With the rise of ESG investments, investors may be able to gain more diversification than SRI funds enjoyed historically. Companies that focus on sustainability and impact management have historically shown the ability to create a stronger long-term enterprise. Thus, the distinction between traditional SRI and ESG investments is very important.
We think that investors should consider a selection of companies demonstrating a commitment to sustainability and impact practices. Fortunately, companies are more frequently reporting SRI data which is increasing in quality as well as quantity. Just 20% of S&P 500 companies issued corporate social responsibility reports in 2011. By 2014, 80% of S&P 500 companies were issuing these reports (Source: Governance & Accountability Institute).
We do note that positive screening is not insusceptible to underperformance. Even if the investor had decided to back a budding clean tech company, the clean tech industry has since gone through significant corrections over the past few years. We think that diversification is still an important consideration.
Bottom line: With the increased popularity of ESGs, we believe that SRI fund performance today is not deserving of this stigma. Investors may benefit from a professional manager who can select companies creating a stronger long-term enterprise through ESG practices.
