These days, most people strive to be looked at as “socially responsible.” This entails doing their part to fight climate change, protect the environment, adhere to policies of diversity, equity and inclusion, prevent sexual harassment in the workplace, and a myriad of other social causes. Until recently, these concerns were looked at apart from one’s investment goals and decision making. But now, these seemingly separate concerns are becoming intertwined with the investment process.
For the non-initiated, ESG stands for Environmental, Social and Governance. Since time began, corporations were thought to exist to serve the needs of their owners, the shareholders. Today, companies must address how their operations and policies serve five groups: employees, customers, communities, the environment, and oh yes, shareholders. CEOs in many of today’s major companies continually evaluate the positive or negative effect on all five groups to determine their ESG “score.”
Why should money managers care about this trend? Because a recent survey conducted by a large investment bank showed that approximately 90% of millennial investors planned to coordinate their investment program with their societal value propositions. The numbers, on a worldwide basis are staggering. Net inflows to ESG funds grew to over $20 billion in 2019 which quadrupled the 2018 number. In Europe, where the trend took root somewhat earlier than in the U.S., fully $132 billion found its way into ESG funds. Clearly, the concerns mouthed by the winners on all the Hollywood awards shows are being taken seriously by a large portion of the investing public.
What are some of the specific questions companies face in designing their ESG programs?
- How do we, as a company, manage our impact on the environment?
- Do we have a diverse workforce?
- What is the company’s mission statement? Is it beneficial to society?
- Does the company “give back” to the community where it is located?
- Do the Board of Directors and top executives take the needs of the five stakeholders into account?
- Is employee pay and benefits fair? Is executive compensation tied to increasing the long-term value of the business?
How companies fare on these and other issues go into their ESG scores. Companies like Bloomberg, Dow Jones, MSCI and Refinitiv provide research on these scores. Various outlets publish “best of” lists of the top ESG companies. If you want more diversity in your ESG portfolio, there are now mutual funds that target ESG-focused companies for their portfolio.
While proponents of ESG reporting say it is essential to keep companies accountable for their actions, the question becomes, is there a cost involved? Does the existence of a strong ESG program result in lower shareholder returns? The critics of socially responsible investing believe that it causes businesses to operate less efficiently. No less an economic expert than the late Milton Friedman, a Nobel prize winner, was a proponent of the belief that companies should focus on bottom-line profits and that expenditures related to social causes merely eroded profits and shareholder value. On the other side, companies like Accenture, SustainAbility and BlackRock’s Larry Fink are strong proponents of including non-financial considerations such as environmental and social factors when evaluating a company’s value. One should consider, however, that Accenture and SustainAbility provide ESG consulting services to companies, while BlackRock has been referred to as the “fourth branch of government” by Bloomberg News.
In 2020, the U.S. Dept of Labor issued a ruling that required fiduciaries of retirement plans to make investment decisions solely on investment performance and not consider more esoteric concerns such as ESG. However, consider that new initiatives in the UK and across continental Europe will require all publicly traded companies to complete ESG reporting annually. And while there is still debate about the SEC’s jurisdiction over this subject, the Commission expects to issue ESG standard disclosure requirements that will go into effect in 2023.
Whatever your opinion on ESG investing, it is clear that this trend will continue to dominate headlines, investment strategies and investor decisions, and most likely affect your compliance requirements as early as next year. Grassi’s Fund Administration and ESG professionals can help you develop and execute a plan to meet the expectations of all stakeholders and regulators. Contact your Grassi advisor or John Zoraian, Fund Administration Principal, to learn more.
