Environmental, Social, and Governance (ESG) factors have been demonstrated by the market to be a permanent consideration for consumers making purchasing decisions. Mobile applications like ThinkDirty rank beauty products based on environmental and health implications. Organic and fair-trade certifications are key marketing points in popular health-orientated grocery stores like Whole Foods.
Why then, is the formidable finance industry stagnating to catch up with the increased demand in accountability? Moreover, investment funds are putting their money into counterintuitive places. Cases like doctors’ pension funds investing in tobacco companies, or teachers’ pension funds investing in companies that use child labour, show how opaque the current infrastructure is.
“If we take a step back, we have 530 million people globally who are fortunate enough to have approximately $100 trillion USD they’re investing,” said Toby Heaps, CEO of Capital Knights during MaRS Discovery District’s Social Finance Forum in Toronto. “That number will become a billion in a decade. The question is, how would the world be different if half a billion people all had investments reflecting their values?”
Market demand for change
In recent years, there have been numerous studies that showed an overwhelming preference by investors to align their investments with their values.
“Millennials are twice as likely to invest in a fund if sustainability is part of the value-creation thesis,” said Audrey Choi, head of Morgan Stanley’s Institute for Sustainable Investing, based on a study conducted in late-2014 with 200 millennial respondents. The institute is working to grow its Investing with Impact Portfolio from its current $6 billion USD to $10 billion USD by 2018. According to Jon Hale, head of sustainability research for Morningstar, emerging investor groups like women and millennials will soon control upward of $30 trillion USD in assets as they amass wealth through earnings and inheritance.
This demand reflects a preference for a more sustainable future, albeit any constraints in the present.
“A lot of people think you can’t exclude fossil fuels in your portfolio if you drive a car, and I would like to disembowel that notion as much as possible,” said Heaps. When you’re a consumer, you’re a price taker, but as an investor you’re in a different position of power. You’re investing in the future and not the here now. You can invest in the world as you want to see it evolve.”
A stronger bottom line
The conception that sustainability focused funds are sub-par in profitability is also being discredited. The Morgan Stanley study looked at 10,228 mutual funds over seven years and found that sustainable strategies yielded returns that matched or outperformed conventional mutual funds 64% of the time.
In addition, the Barclays Quantitative Portfolio Strategy Research team published a report earlier this month that investigated the relationship between ESG investing performances in the US corporate bond markets. Of the key findings, Barclays found that including ESG factors into the investment process resulted in a small but steady increase in returns that aren’t caused by high-ESG bonds becoming more expensive with increasing demand.
Barriers to value investing
Heaps listed five barriers that have prevented the vast majority of investors from aligning their investments with personal values. First, there is a lack of active deliberation on the companies being invested in. Second, there is a lack of efficient financial infrastructure for individuals to invest sustainably. Third, there is a general mistrust and perceived lack of transparency in voluntarily disclosed company information. Fourth, there is no quick way for investors to check how their returns compare with funds that are unscreened for sustainability. Finally, there is a lack of personalization in ESG criteria for individual investors.
“There’s no made-to-order pizza,” said Heaps. “There are only a few flavours – you better like pepperoni or pineapple, or you’re out of luck. What if you can make it personal to your own preferences in a way that would not be more expensive?”
Overcoming the barriers
In Q2 of next year, Corporate Knights will be releasing a web application that allows portfolio investors to choose positive and negative investment criteria. Investors can choose from a list of exclusionary criteria, such as controversial weaponry or animal testing. On the other hand, investors can select inclusionary criteria, like female executive representation and renewable energy use.
“We’ve been writing about sustainable investing since 2003, doing rankings since 2002. In 2010 we started doing the Global 100 rankings, and that’s when we came up with the idea,” said Heaps. “The ultimate goal we had is to shift trillions of dollars from companies causing harm to sustainable ones helping the planet.”
Investing in a sustainable future
When will impact investing become the norm? Bloomberg and Morgan Stanley published a survey last week that showed 89% of asset managers were familiar with sustainable investing and 65% currently practise it. Among respondents who do not practise sustainable investing, more than half believe adoption will increase in the next five years. Among respondents who do practice sustainable investing, more than half will plan new ESG strategies in the next 12 months.
With the world’s population to increase from 7.3 billion to 9.7 billion by 2050, with resource and environmental strains, it seems that accessible sustainability investing will change from a preference to a need that needs to be fulfilled.