August brought one of the most seismic shifts in capital- ism’s history when nearly 200
CEOs of America’s largest companies,
collectively known as the “Business
Roundtable,” agreed to redefine the central purpose of the corporation. No longer, the Business Roundtable declared,
will the focus of the corporation be
to maximize shareholder profits at any
expense. Rather, the new central purpose of the corporation is to focus on
delivering value to multiple social stakeholders — including employees, consumers and communities.
Why should advisors care? Because
this new wave of social responsibility
has come to Wall Street not by way
of regulators or politicians, but from
the millions of everyday investors who,
through the allocation of their retirement savings, are now applying bone-crushing pressure to the world’s largest
and most powerful multinationals to
clean up their act.
This trend is fueled by three developments. First, today’s investors are more
educated and better informed than at
any time in history, which has led to a
growing awareness of both the plethora
and seriousness of the issues confronting society. In the age of social media,
companies who commit environmental
atrocities or engage in abusive labor
practices can be mercilessly punished
by consumers (via boycotts that hurt
revenue) and investors (who drive up
the cost of capital for offenders).
Second, there is growing consensus
that government action by itself is a necessary but insufficient solution to some of
society’s most pressing challenges, such
as climate change and social inequality.
Finally, seismic demographic and economic shifts have brought more women
and millennials, who generally tend to
be more socially conscious investors,
into global capital markets.
SRI, ESG & IMPACT: WHAT’S IN A NAME?
Don’t be confused. The key word is
“investing”; this is not about philanthropy. Regardless of the label, all of these
approaches are ultimately about seeking
a positive financial return while bringing about positive change in some way.
SOCIALLY RESPONSIBLE INVESTING
Socially responsible investing typically
refers to constructing portfolios using
“negative screens” to exclude firms or
sectors involved in activities investors
deem to be unacceptable or controversial,
such as excluding firms that sell weapons.
ENVIRONMENTAL, SOCIAL &
ESG investing, while related to SRI, is
materially different. ESG investing
focuses on investing in companies with
high ESG scores relative to their peers.
Subsequently, ESG investing doesn’t nec-
essarily exclude “bad actors”; it focuses on
firms with high sustainability ratings rela-
tive to their peers. It’s an approach that
subsequently focuses on “best-in-class”
firms but doesn’t explicitly exclude any
firm or industry.
Impact investing essentially is a hybrid
taking from SRI and ESG investing. It goes
further by focusing on solving specific
social or environmental problems in two
ways. First, it explicitly focuses on those
companies with the best ESG scores, and
second, it typically excludes companies
engaged in undesirable activities.
Modern Portfolio Theory suggests
that limiting the investing universe
results in the construction of a less risk-efficient portfolio. However, there is
now a considerable amount of academic
evidence that proves SRI — in all its
forms —does not reduce performance.
There’s even some real-world evidence
that SRI can result in outperformance. The
MSCI KLD 400 Social Index is an index
of 400 U.S. companies with high ESG
ratings and excludes companies whose
products have negative social or environmental impacts. Since its inception on
May 31, 1990, the index had an annualized
return of 10.50% versus 10.08% for the
S&P 500 Index (per FactSet Inc.)
Clients increasingly demand that their
portfolio managers take ESG issues into
consideration when building portfolios.
Advisors would do well to get up to speed
on ESG-related terminology and understand the impact ESG mandates might
have, if any, on portfolio returns.
Donald Calcagni is chief investment officer of
By Donald Calcagni
It’s Time to Take ESG Investing Seriously
Socially responsible investing has hit Wall Street via clients, and now
advisors need to get up to speed.