Monique Frederick, Butterfield
Socially responsible investing has been referred to by many names, including sustainable, responsible and impact investing. In essence, socially responsible investing is an investment approach that considers environmental, social and governance (ESG) factors in portfolio selection. An estimated $23 trillion in assets are currently managed under responsible investment strategies, and this is only expected to grow.
Baby boomers and Gen Xers still favor traditional investment strategies, while millennials and female investors are increasingly focusing on ESG factors alongside investment returns. Individuals in this demographic want their investment dollars to be aligned with their personal views and they spend more time considering how they can have a positive impact on the world.
Admittedly, there is no lack of skepticism as to the ability of sustainable investments to keep up with traditional investment returns. Although the results from studies comparing SRI versus traditional stock performance are mixed, there are recent studies emerging suggesting that the inclusionary method of ESG implementation could result in superior performance in the long-run. As SRI implementation methods are refined, clear quantitative measurements are developed and, as more data becomes available, better research and analysis will undoubtedly emerge in the future. What is of importance today is the growing demand from investors and asset owners for socially responsible investment options.
So what’s driving this demand?
Investors cite various reasons for adopting ESG investing goals. Some include trying to end business practices that are deemed morally or socially problematic, avoiding possible legal and adverse publicity, and lowering risk. The primary motivation, however, appears to be alignment with one’s own ethical values. Investors – more so in Europe – are demanding that the investment decisions being made by investment managers are congruent with their societal views. It has also been widely reported by banking behemoths like Bank of America Merrill Lynch and others that companies with higher ESG scores tend to have lower stock price volatility.
So maybe millennials are idealistic; will they change their tune as they get older? I firmly believe that our past experiences greatly influence our future behavior. Having experienced the financial crisis and climate change, it should not come as a surprise that the younger generation approaches investing from a different perspective. Additionally, a number of mainstream firms have already started answering the call by launching sustainably managed products or funds.
Not all SRI funds are created equal, as there are various ways of implementing an ESG strategy. The exclusionary method focuses on excluding companies from a portfolio based on certain factors. Excluding tobacco companies from a portfolio is one example of utilizing this approach. Another method gaining greater popularity is the positive screening approach where companies are selected based on how well they manage environmental, social and governance issues versus their peers. Selecting a company for its high marks for gender diversity in management is an example of an inclusion strategy, as is selecting a company which has implemented best management practices to avoid environmental risks.
In addition to exclusionary and positive screening, sustainable investment strategies also include norms-based screening, ESG integration, sustainability-themed investing, impact investing, and corporate engagement and shareholder action. The Global Sustainable Investment Alliance (GSIA) provides more detail on these classifications in its Global Sustainable Investment Review report. Out of this list, retail investors may be most familiar with impact or community investing, where capital is specifically directed to solving a social or environmental problem or to underserved communities.
Demographic changes as a result of the intergenerational transfer of wealth suggest a shift to younger investors and greater female participation in the future. Consequently, the demand for ESG investment mandates will only gain more momentum. Not only is this demand driven by individual investors, but pension and endowment funds are also starting to show interest, with Europe leading the way. Furthermore, as the forecasts for lower future expected returns in both fixed income and equity markets become a reality, investors may very well demand that their investment dollars deliver more than just a financial return. Needless to say, I believe this trend is here to stay
Sources: Global Sustainable Investment Alliance, Barclays, Alliance Bernstein, U.S. Trust – Bank of America.
The views expressed are the opinions of the writer and while believed reliable may differ from the views of Butterfield Bank (Cayman) Ltd. The Bank accepts no liability for errors or actions taken on the basis of this information.