ByPeter Essele:
In the past, the concept of
"socially responsible investing" often elicited visions of the
left-leaning portfolio manager sitting at his desk wearing
Birkenstocks and a tie-dyed T-shirt. In reality, this couldn't be
further from the truth. Over the last decade or so, socially
responsible investing ((
SRI
)) has evolved from its humble beginnings as a fringe form of
investing to one of the fastest-growing areas of the investable
spectrum.
According to the Social Investment Forum, SRI-more commonly
referred to by the investing community as the environmental,
social, and corporate governance ((ESG)) space-surged from $639
billion in 1995 to $3.07 trillion at the start of 2010. During the
same period, the number of investable vehicles incorporating ESG
factors increased from 55 to nearly 500. One reason for this growth
may stem from the fact that investors are paying more attention to
such terms as
corporate governance, social responsibility,
sustainability,
and
environmental impact
, and these factors are having an increasingly greater influence on
where they decide to invest their money. As a result, the ESG
space, which has long been considered an underperformer, is showing
strong growth potential - and turning business and industry
leaders' heads.
The Performance Hurdle: It's More Than Just
"Green"
One primary area of contention within the ESG space has been
performance. The prevailing assumption in the investing
community-and a topic that many studies have addressed - is that
ESG managers typically lag the overall market. A joint study by
Harvard University and London Business School has found the
opposite to be true. Researchers found that, over an 18-year period
ending December 2010, $1.00 invested in a value-weighted portfolio
consisting of
high sustainability
organizations that had adopted a number of environmental and social
policies grew to $22.60, whereas a similar
low sustainability
portfolio grew to only $15.40.
Another reason for this perceived underperformance may have to
do with investors' earlier tendency to focus only on the
environmental aspect of ESG, which is often equated with "green"
investing. Arguably, the corporate governance and social portions,
which more investors now seem to be considering, have a greater
effect on long-term performance.
Many analysts, including CFA charterholders, are trained to
focus on corporate governance in their security evaluations, and
they often attribute long-term stock price appreciation to strong
corporate governance practices, such as independent board
membership, the use of independent audit committees, and
maintenance of a culture focused on the basic principles of
integrity, trust, and honesty. According to GMI, a global leader in
corporate governance ratings and research, companies with the
highest corporate governance ratings outperformed the Russell 1000
Index by an annualized 275 basis points from 2002 to 2010.
In addition to good corporate governance, evaluating a company
based on whether it has strong social practices and no history of
discrimination can lead investors to promising investment options.
According to a study on employee satisfaction and long-run
performance by Alex Edmans, a professor at the Wharton School, a
"value-weighted portfolio of the '100 Best Companies to Work for in
America' earned an annual four-factor alpha of 3.5 [percent] from
1984 to 2009, and 2.1 [percent] above industry benchmarks."
Performance in practice.
For a practical validation of performance, you can scroll through
the Morningstar® SRI screen and find a number of four- and
five-star funds that have outperformed their broader peer groups on
a consistent basis.
Although past performance doesn't guarantee future results, it
does back up recent studies suggesting that ESG can
out
perform. And, given these findings, I don't believe it is a stretch
to assume that the fundamental concepts of ESG could lead to
positive price appreciation over time, especially when you factor
in the mounting interest in the space and the increasing number of
assets seeking ESG-like investments.
Moving To The Mainstream
I would argue that it is highly likely that underperformance in
the ESG space has had more to do with a lack of resources and
manager experience than the actual ESG overlay. Traditional money
managers typically have a large number of analysts at their
disposal. This has allowed them to cast a larger net - by attending
trade shows, meeting with company management, and the like - to
gather more information. Now that more assets are flowing into the
ESG space, taking it from the fringe to the mainstream, this
resource imbalance appears to be changing.
As mentioned above, ESG assets grew from $639 billion to $3.07
trillion between 1995 and 2010, outpacing the growth of overall
market assets by 120 percent. A more recent example of this growth
disparity between ESG and traditional assets can be seen by looking
at AUM growth of PIMCO Total Return III and PIMCO Total Return,
both of which are run by one of the most noteworthy traditional
bond managers in recent times. The ESG fund's AUM grew 7 percent in
2011, while assets in the traditional fund grew by just 1 percent -
an indication that investors are placing greater emphasis on what a
fund invests in.
More conventional ETF providers, including iShares and First
Trust, are beginning to offer socially responsible options as well
- e.g., iShares MSCI USA ESG Select Index (
KLD
), First Trust NASDAQ Cln Edge Green En Idx (
QCLN
). If this trend continues and investor awareness expands even
more, I think it is safe to assume that more resources and better
talent will undoubtedly follow the asset flows, and any performance
disparity that may have existed historically will narrow further in
the years to come.
Businesses' Interest In ESG
Certain businesses and industries have been taking note of the
increasing interest in ESG factors over the last few years as well,
and it seems to further validate the long-term growth trend we're
seeing in this space. Lobbying dollars to Washington have increased
by more than 100 percent in the last decade in an attempt to
influence legislators regarding oil industry policy. Of course, a
lot of money has been spent trying to overturn certain EPA
standards that are viewed as negatives for the oil and gas
industry. At the same time, this activity signifies how much
environmental factors have been influencing policy decisions.
Further, many companies have been dedicating advertising dollars
to clean up their corporate images. One of the strongest efforts
has come from oil companies, such as Shell, which have spent large
sums of money trying to "green" their corporate image by touting
green technology aimed at reducing CO2 emissions and improving
efficiency. In addition, major corporations, including Bank of
America (
BAC
) and General Electric (
GE
), have fought hard to improve perceptions of their workplace
culture, social practices, and executive compensation, factors that
were of much less concern to investors in the 1980s and 1990s.
Finally, in a sign that the global investing community has also
embraced ESG investing, many public employee pension plans and some
private company and union pension plans have added ESG language to
their investment policy statements. According to the CFA Institute,
the United Kingdom introduced legislation concerning ESG criteria,
which has contributed significantly to the growth of socially
responsible investing in pension plans throughout the region. If
similar measures are implemented domestically, one could assume
that a similar growth would result.
ESG Is Here To Stay
In a world where individual investor insight into the asset
management process is becoming more commonplace, the practice of
evaluating companies based on strong corporate governance
standards, first-rate social practices, and clean environmental
track records is becoming more mainstream. And as more and more
investors become aware of such issues, we can only expect the ESG
space to continue to grow - and potentially provide investors with
attractive investment returns.
Disclosure:
I have no positions in any stocks mentioned, and no plans to
initiate any positions within the next 72 hours. I wrote this
article myself, and it expresses my own opinions. I am not
receiving compensation for it. I have no business relationship with
any company whose stock is mentioned in this article.
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