The Big Money
For decades, the socially responsible investing movement was looked upon as a niche populated by churches, environmentalists and idealists of various stripes -- not a place for serious investors. But that is slowly changing as huge government-run pension funds begin to look at an offshoot of socially responsible investing as a possible way to feed their anemic coffers.
These funds are focusing on the extra-financial criteria used to make investment decisions, paying special attention to environmental, social and governance considerations. The discipline, known as ESG investing, weighs a company's commitment to easing global warming, its waste-management practices, and its policies dealing with corruption and bribery, among other things. The idea is that when companies handle these factors in a favorable manner, they are more sustainable and therefore more likely to be profitable in the long term.
Public pension funds in states such as Connecticut, Illinois, New York and Washington have in recent years begun dribbling assets into the emerging sector, and experts think these investments will only become more common. The $787 billion stimulus package, for example, contains $106 billion in climate-change-related initiatives, and the International Energy Agency estimates that about $45 trillion will be needed in the next 40 or so years to develop and deploy new clean technologies.
Some state funds already have taken meaningful steps toward adopting ESG into their mainstream investment process. Investment officers for the state treasury in Florida formally began incorporating the financial impact of climate change into their investment decision-making last year as well as ranking outside asset managers on their ability to choose climate-friendly stocks. In January, the state of California's public-employee pension plan, the second largest in the country by asset size, created a new position for a chief of corporate governance who will oversee shareholder activism.
What the sector lacks in participants it makes up for in esteem. Well-known firms including UBS; Goldman Sachs Asset Management; DB Advisors, Deutsche Bank's asset management arm; and State Street Global Advisors, each of which manage billions of dollars for institutional investors, have in the past few years launched ESG strategies. Mercer, which advises $3.7 trillion in assets globally, began assessing managers based on their ability to integrate ESG factors into their stock appraisal last year, and Evaluation Associates and Watson Wyatt Worldwide have built their own dedicated ESG teams.
One factor that will determine how big ESG investing becomes is whether it can transcend the reputation of socially responsible investing. SRI first gained traction among religious organizations, whose aim was to screen out "sin stocks," or those linked to tobacco companies and gun makers, for instance, in the 1960s. Over the past two decades, SRI has taken an activist bent by expanding to include shareholder advocacy (such as proxy voting) and community investing.
"SRI often implies an ethical or social objective, whereas ESG comes from a fiduciary, risk/return perspective," explains Craig Metrick, U.S. head of responsible investment at Mercer Investment Consulting, which advises pension funds and other institutional investors on asset allocation and which money managers to hire. "So for example, an SRI investor may be very concerned with screening out gambling or weapons from the portfolio, but I wouldn't consider that an ESG issue," he says.
According to the Social Investment Forum, $2.7 trillion was invested in socially responsible funds in the United States as of 2007, an 18 percent increase from 2005 and a 324 percent increase from 1995. However, the amount that is currently invested has in all likelihood shrunk as asset values diminished in 2008. It's not known how much is invested in ESG alone.
In fact, the data on ESG are spotty all around, and much of the existing numbers on returns extend only one or two years. An exception is the Domini 400 Social Index, which includes a negative as well as positive screen and has been around since 1990. The index returned -34.84 percent for the year ended Dec. 31, 2008, beating out the S&P 500, which posted -37 percent returns.
It is also unclear whether ESG, in fact, leads to better returns. A review conducted by the United Nations Environment Program Finance Initiative and Mercer of 20 studies that examined the link between ESG factors and investment performance found that 10 studies indicated a positive correlation, while seven found the relationship to be neutral. Three studies concluded that ESG criteria have a negative impact on returns.
Given this, pensions dabbling in the area are constantly defending the strategy's profitability. Trustees and staff members who constitute the boards of pension funds are obligated by law to act in the best interest of their beneficiaries -- an especially touchy topic now as some plans are underfunded by billions of dollars and many have lost crippling sums to alleged securities fraud.
Other obstacles in the way of widespread ESG adoption, as identified by the Business for Social Responsibility, a San Francisco-based consultancy, are "short-termism" (an amusingly diagnostic way of describing when an investor only focuses on short-term returns) and the lack of a uniform accounting method to gauge the impact ESG factors have on stock prices. Plus, as formerly well-fed money managers are being purged of their staffs in sweeping layoffs, the prospect of having to do more work -- picking stocks using ESG criteria is no easy task -- with fewer resources is not being met with enthusiasm.
So if ESG is actually the next era of socially responsible investing, we're not quite there yet. But as sure as climate change is making sea levels rise, if it makes investors money, they will find a way to stop it.