But in recent years, institutional investors and pension funds have grown too large to diversify away from systemic risks, forcing them to consider the environmental and social impact of their portfolios. Analysis of interviews with 70 executives in 43 global institutional investing firms suggests that ESG is now a priority for these leaders and that corporations will soon be held accountable by shareholders for their ESG performance. To respond to this shift in focus, companies must publish a statement of purpose, provide investors with integrated financial and ESG reports, increase the involvement of middle managers in ESG issues, invest in robust IT systems, and improve internal systems for measuring and reporting ESG and impact performance information.
For years, environmental, social, and governance ESG issues were a secondary concern for investors.
Today institutional investors and pension funds have grown too large to diversify away from systemic risks, so they must consider the environmental and social impact of their portfolio. Interviews with 70 executives in 43 global institutional investing firms found that ESG is top of mind for these executives. Corporations will soon be held accountable by shareholders for their ESG performance.
To respond, companies must publish a statement of purpose, share an integrated report with investors, increase the involvement of middle managers, and improve internal systems for measuring and reporting ESG and impact performance information. Most corporate leaders understand that businesses have a key role to play in tackling urgent challenges such as climate change.
But many of them also believe that pursuing a sustainability agenda runs counter to the wishes of their shareholders. Sure, some heads of large investment firms say they care about sustainability, but in practice, investors, portfolio managers, and sell-side analysts rarely engage corporate executives on environmental, social, and governance ESG issues. That perception is outdated.
We know of no other research effort that involved so many senior leaders at so many of the largest investment firms. We found that ESG was almost universally top of mind for these executives. Of course, investors have been voicing concerns about sustainability for several decades. But not until recently have they translated their words into action.
Most of the investment leaders in our study described meaningful steps their firms are taking to integrate sustainability issues into their investing criteria. The numbers back up the view that the capital markets are in the midst of a sea change. According to a global survey by FTSE Russell, more than half of global asset owners are currently implementing or evaluating ESG considerations in their investment strategy. Yet many corporate managers seem to be unaware of this new reality.
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Sustainable investing encompasses a menu of strategies that can be used in combination. Here are seven common ones:. The first step corporate leaders can take to prepare for this shift in focus is to recognize the forces driving it.
Once they understand why investors now care so much about ESG issues, they can make changes within their organizations to maximize long-term value for shareholders. Over the past five years or so, investors have become increasingly interested in ESG issues. Six factors are acting as tailwinds for this heightened focus. The investment industry is highly concentrated. The top five asset managers hold Large investment firms are now so big that modern portfolio theory—which holds that investors can limit volatility and maximize returns in a portfolio by combining investments from asset classes with varying levels of risk—cannot be used to mitigate system-level risks.
But firms that have trillions of dollars under management have no hedge against the global economy; in short, they have become too big to let the planet fail. Many corporate managers still equate sustainable investing with its predecessor, socially responsible investing SRI , and believe that adhering to its principles entails sacrificing some financial return in order to make the world a better place. That view is outdated. In a different study, Serafeim and his colleagues demonstrated the positive relationship between high performance on relevant ESG issues and superior financial performance.
Executive Quarterly View Current Issue. Frequently Asked Questions. The document linked political security with 'economic prosperity and social justice'. When women are empowered economically, they invest in their families and communities, spurring economic growth and creating more stable societies. In December, 2. Where needed, corrective action plans were developed. The worries so far appear unfounded.
In , Bank of America Merrill Lynch found that firms with a better ESG record than their peers produced higher three-year returns, were more likely to become high-quality stocks, were less likely to have large price declines, and were less likely to go bankrupt. For European portfolios, governance is particularly important for determining outperformance. For North American portfolios, environmental factors are the most significant. Sustainable investing is about materiality. Materiality varies by industry. For example, material issues for companies in food retail and distribution include greenhouse gas emissions, energy management, access and affordability, fair labor practices, and fair marketing and advertising.
For internet and media services the list includes energy management, water and wastewater management, data security and customer privacy, diversity and inclusion, and competitive behavior. A study by Mozaffar Khan, George Serafeim, and Aaron Yoon provides empirical evidence that good performance on material issues contributes to higher financial returns.
Most tellingly, the researchers found that whereas firms with good ratings on material sustainability issues significantly outperform firms with poor ratings on those issues, firms with good ratings on immaterial issues do no better than firms with poor ratings on those issues. Asset owners such as pension funds are increasingly demanding sustainable investing strategies from their asset managers.
Not only are sophisticated asset owners aware that sustainable investing improves returns, but many of them, including high-net-worth individuals, are also focused on the nonfinancial outcomes. Firms with trillions under management have become too big to let the planet fail. The demand for ESG investment options is so high that many asset management firms are rushing to pull together new offerings. Asset owners no longer have to be convinced that sustainable investing is important.
A corollary to the mistaken belief that sustainable investing means sacrificing some financial return is the belief that fiduciary duty means focusing only on returns—thereby ignoring ESG factors that can affect them, particularly over time. However, more recent legal opinions and regulatory guidelines make it clear that it is a violation of fiduciary duty not to consider such factors.
Although adoption of this new understanding has been slow in the United States, other countries, such as Canada, the UK, and Sweden, are taking steps to redefine the fiduciary duty concept.
It is one thing for the CEO or chief investment officer of a major investment firm to espouse sustainable investing and quite another for it to be practiced by the analysts and portfolio managers who make the day-to-day investment decisions. Historically, the ESG group at investment firms was separate from portfolio managers and sector analysts on both the buy side and the sell side in much the same way that corporate social responsibility groups were historically separate from business units.
Now senior leaders are making sure that ESG analysis is being integrated into the fundamental financial activities carried out by analysts and portfolio managers. This has been an internal cultural evolution. This shift will change the way investors engage with companies—and the way corporate executives view sustainability. Tariq Fancy, the chief investment officer of sustainable investing at BlackRock, equates integrating ESG considerations into traditional financial analysis to an exercise in behavior change.
Given the size of BlackRock, changing investor behavior across the organization will require time and hard work. Making the job of Fancy and other chief investment officers easier is the fact that the workforce is increasingly made up of Millennials, for whom ESG is central to any business analysis.
Shareholder activism is on the rise in financial markets—and ESG is increasingly becoming a focus of these interventions. But active managers who intend to hold a stock for a long time and passive managers who hold a stock forever have an incentive to see that companies address the material ESG issues that will improve their financial performance.
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