Here's a provocative statement: in 10 years, nearly all investment strategies will involve some form of sustainable and responsible investment. Environmental, social and governance (or ESG) analysis is already moving into the mainstream. Over the next decade, we expect individual and institutional investors to increasingly demand that their advisors consider these factors when recommending investments.
What's changed? As you may know, sustainable and responsible investing has been around for centuries, going back all the way to Colonial times when groups like the Quakers and Methodists refused to invest in the slave trade. These early strategies gained wider traction in the 1960s when people began to extend their opposition to the Vietnam War, environmental damage and unsafe products to their investment portfolios. The idea really took off in the late 1970s and 1980s, as institutional and retail investors began to look for ways to voice their disapproval of South Africa's apartheid regime.
During the 1990s, a series of corporate scandals—like Enron, Worldcom and Global Crossing—focused investor and public attention on corporate governance. At the same time, mounting concerns about global warming forced companies to confront their exposure to climate change risk.
Forward-thinking investors began to look at a commitment to ESG management not just as evidence of good corporate citizenship, but as a way to manage risk.
All that has resulted in strong growth in SRI investing. Consider that in 2010, investors held more than $3 trillion in SRI assets in the United States. Moreover SRI assets are increasing much faster than the market as a whole. From 1995 to 2010, SRI investments grew by 380%, versus just 260% for all professionally managed assets, according to a report last year by the Social Investment Forum Foundation.
As an advisor, you can get in front of this trend by educating yourself about the SRI market and offering these strategies to clients. Here are some key ideas to focus on when discussing the increasing importance of this sector to sophisticated investors:
1: SRI strategies perform at least as well as unscreened ones
For many years, investment professionals argued that considering social, environmental and governance factors constrained their ability to achieve optimal results for clients. Even considering ESG, they argued, was a breach of their fiduciary duty to consider only the interests of their clients. And yet, more recently, academic research has shown that SRI strategies perform at least as well as non-SRI. And, they may even provide higher risk-adjusted returns. For instance, a 2007 study by the Massachusetts Institute of Technology found that stocks of companies on Fortune magazine's "100 Best Companies to Work For" list outperformed market averages, even after accounting for market risk, size, and momentum and style effects. Another study from Santa Clara University, completed in 2008, revealed that companies with high corporate social responsibility scores tended to outperform the market. And, in 2000, a study in Management Science found that companies that met the highest environmental standards tended to have higher valuations than those that did not. These studies suggest that there is no performance penalty for investing responsibly—and that these strategies may even provide superior returns.
2: ESG screening may cut risk
Companies that meet high standards for environmental stewardship, social responsibility and governance are less vulnerable to a whole range of risks—from the accounting scandals that plagued poorly governed firms like Enron to the enormous costs of environmental clean-up incurred by BP and General Electric. Many institutional investors are now demanding that their asset managers incorporate these factors into their due diligence, not because of the social impact of poor ESG performance, but as a way to manage and minimize investment risk.
3: Sustainability leaders are at the forefront of fast-growing industries
A new emphasis on sustainability is fueling innovation and rapid growth in industries like alternative energy, water and energy conservation. Even in more traditional sectors, companies that focus on sustainability can gain a competitive edge by reducing packaging and transportation costs and developing more energy-efficient operations. By investing in companies that meet and exceed standards for corporate responsibility, your clients can increase their exposure to tomorrow's growth leaders.
4: Institutional demand will increase the value of sustainable companies
The world's largest investors—for instance, pension funds like the California State Teachers Retirement System (CalSTRS) and the California Public Employees Retirement System (CalPRS)—are beginning to demand that their investment managers include ESG factors into their investment decisions. This ultimately can increase valuations of companies that meet high ESG standards and put downward pressure on the prices of those that do not. Institutional demand also may, in time, put a premium on sustainable and responsible stock prices, which can only benefit individual investors who hold these stocks.
5: Different strategies can meet different needs
The SRI industry now offers a very broad range of investment products, spanning all the major asset classes, capitalization sizes and world markets. Investments are available in a variety of formats as well, from mutual funds, to separately managed accounts to exchange-traded funds. Moreover, there are many different types of SRI investments that reflect different values and priorities. At Calvert Investments, for instance, we offer three different types. Our Signature funds are traditional SRI vehicles, which screen stocks based on a list of seven ESG criteria. Our Solution funds concentrate on companies and industries that are solving specific sustainability challenges. And, finally, our SAGE Funds seek sustainability through greater direct company engagement. Those engagements allow Calvert to focus not just on companies that meet our traditional screens, but on a select number of companies that do not. Then we work with these companies to help them improve in areas where they fall short.
6: SRI can drive real change
Finally, a focus on sustainability has already had-and will continue to have—a positive impact on our world. Today, multinational companies are leading the effort to conserve energy and reduce emissions, to increase the diversity of their employees and management teams, to maintain fair labor practices and to institute better, more transparent governance procedures. In many cases, these companies are adhering to standards that are higher than what their governments and regulators currently demand of them. That's largely because of the pressure that SRI investors have put on them. And, we believe as SRI becomes more mainstream, this pressure can only intensify, creating a better world for all of us now and for future generations.
Anthony Eames is a senior vice president with Calvert Investment
Distributors Inc., a subsidiary of Calvert Investments Inc.