By early 2018, funds guided by environmental, social and governance (ESG) issues totaled $98 billion in the United States, a 58% increase over the previous year, according to a 2018 Morningstar report.
Data Drives the Message
Helping drive the surge is mounting evidence that ESG investments may perform as well or, in some cases, even better than traditional ones. For example, among exchange traded funds (ETFs) with an ESG focus and in operation for at least a year, 57% performed better than a broader index of ETFs in 2017, according to ETF.com.1 Yet as encouraging as such studies may be for sustainable investors, head-to-head comparisons tell only part of the story, says Aniket Shah, Head of Sustainable Investing at OppenheimerFunds. “You can’t just hang your hat on the question of direct outperformance.”
More compelling, Shah believes, is the idea that, as global awareness of environmental and social challenges rises, all companies must consider sustainability as integral to their operations. In 2016, a landmark Deutsche Bank analysis of 2,200 studies found that, in most cases, a good record on environmental and other sustainable issues correlated with strong corporate financial performance.2 Businesses are taking notice. In 2017, 85% of S&P 500 companies reported on ESG issues in their own businesses, compared with just 20% in 2011.3
Investors, too, will need to assess the risk of investing in companies that do or don’t demonstrate sustainable values, Shah says. “The data around ESG issues is improving exponentially,” he adds. “A portfolio should take into account long-term risks around things like climate change and poor governance.” New breakthroughs in artificial intelligence, for example, may help investors better understand how ESG factors affect individual companies’ performance.
Will Advisors Fill the Knowledge Gap?
Yet even as the data grow, many investors remain confused about basic aspects of sustainable investing. That’s one of the key findings from The Generations Project, an OppenheimerFunds’ study of financial attitudes and decisions among high-net-worth investors and advisors. Among 500 U.S. investors surveyed, while 29% reported owning sustainable investments, nearly a third of those who own them were unsure what proportion of their overall investments sustainable investments comprise.
Uncertainty may lead to reluctance to become involved. In The Generations Project U.K. survey, while 39% of Millennial investors expressed an interest in sustainable investing, just 14% had followed through.
Moving forward, financial advisors can certainly play a key role in educating their clients, Shah says. (Advisors can find more related articles and resources here.) At the same time, The Generations Project suggests a potential disconnect between financial advisors and clients when it comes to financial returns. While 25% of U.S. investors cited long-term returns as their top sustainable investing priority, only 10% of U.S. advisors believe their own clients feel that way. (U.K. results showed a similar discrepancy (16% vs. 6%, respectively)).
According to Shah, advisors who recognize that sustainable investing represents much more than a “feel good” exercise for investors have the opportunity to help clients meet meaningful goals—and to enhance their own practices. After all, in an age when financial advice is becoming increasingly automated, “sustainable investing opens the door to meaningful, person-to-person conversations touching on clients’ deepest-held values.”
Taking the Long View
Those conversations should emphasize that sustainable investing is a long-term proposition, Shah adds. Corporate practices such as good governance and environmental sustainability are likely to make companies stronger performers over many years, rather than all at once. “Investors should look 10 or 20 years into the future,” Shah says, “and align their investments with the idea that we’ll still have a world we can live in 10 or 20 years from now.”
Already, the European Commission has proposed measures to formally engage the financial community in fighting climate change. Proposals range from requiring institutional investors to show how they factor ESG into investment decisions to ensuring that financial advisors include ESG when discussing investments with individual clients.4
While such initiatives have been slower to develop in the United States, ESG investing options continue to expand. Forty new ETFs and mutual funds focusing on sustainability were released in 2017, compared with just eight in 2013,5 and some firms now focus exclusively on sustainability. One, called Swell (swellinvesting.com) enables individuals to invest in portfolios focused on green tech or clean water, or in the company’s Impact 400 fund, comprising top companies across many themes.6
By every indication, investor interest will only grow in the years to come. Studies show particular interest among women and Millennials, whose rising financial power is transforming every corner of the economy. “But this isn’t just about demographic groups,” Shah says. “There is a ground swell of interest across age, gender, and geography.” In The Generations Project, for example, younger Millennials (age 22-30) and members of the Silent Generation (age 73-90) both identified water preservation among their top sustainable investing priorities.
“What’s becoming more and more clear, to more and more people, is that for the sake of their own financial future and for the future of the world, these are issues we can’t afford to ignore,” said Shah.
Read the full Generations Project study here.
- ^Source: https://www.etf.com/publications/etfr/performance-turning-point
- ^Source: https://www.db.com/newsroom_news/2016/ghp/esg-and-financial-performance-aggregated-evidence-from-more-than-200-empirical-studies-en-11363.htm
- ^Source: Governance and Accountability Institute, as of 12/16.
- ^Source: http://europa.eu/rapid/press-release_IP-18-3729_en.htm
- ^Source: Morningstar Direct, as of 12/31/17.
- ^Source: https://www.swellinvesting.com/offerings
Mutual funds and exchange traded funds are subject to market risk and volatility. Shares may gain or lose value. The stocks of companies with favorable ESG practices may underperform the stock market as a whole.