ESG Investing Momentum Grew in 2016

Moving into the New Year, plan sponsors may want to keep an eye on ESG funds, as they have seen substantial growth this year.

Following regulatory changes enacted late last year, 2016 saw an increased interest in investments chosen with environmental, social and governance (ESG) considerations.

ESG investing assets climbed to $8.72 trillion in the United States, according to a recent report by U.S. SIF, the research and advocacy organization supporting ESG and sustainable and responsible investing (SRI). This hike marked a 33% increase from 2014.

Today, ESG components extend far beyond a company’s environmental footprint to include its record on labor standards, human rights, political contributions, community impact, and more. These factors are increasingly being considered by asset managers alongside economic and financial metrics, when it comes to evaluating company stocks and other funds.  

In the retirement space, these components could once only serve as tie breakers when comparing economically similar funds to include in a retirement plan’s investment menu. But with regulatory and market changes, ESG is no longer viewed as a political act that may undermine risk/return profiles. In fact, more and more research indicates that ESG portfolios are actually outperforming broad market indices. Calvert Investments found that between December 2008 and December 2014, its Calvert Social Index (CSI) outperformed the Russell 1000 Index by 142 basis points (bps) on an annualized basis, for example.  

Gregg Sgambati, a former RIA and current head of ESG solutions at S-Network Global Indices, told PLANSPONSOR he expects in the coming years to see more work being done on building ESG indexes and models to support a variety of funds and data products in the expanding domain.

A recent report by Asset Owners Disclosure Project (AODP), a nonprofit group “advocating to protect retirement savings and other long-term investments from the risks posed by climate change,” suggests there is no correlation between an investor’s decision to actively favor low-carbon investments and the likelihood of experiencing lower returns.

ESG also is becoming increasingly popular among individual investors, especially with Millennials. The Schroders Global Investor Study 2016 found that this generation ranked ESG factors as equally important as investment outcomes, when considering investment decisions. Some even said they would pull funds away from companies with poor ESG records.

According to Cerulli’s third quarter 2016 issue of The Cerulli Edge, even institutional investors are recognizing the “material” impact of ESG, and are now taking these factors into consideration alongside revenue, profitability and valuation when examining funds.

In 2016, 37% of institutional investors incorporated ESG factors into decision making, up from 29% in 2015, according to Callan’s fourth annual survey to assess the ESG factor integration in the U.S. institutional market.

The risks of climate change alone are putting pressure on companies with less-than-adequate environmental records, especially following heightened regulations and potential penalties on carbon emissions.

According to research by U.S. SIF, asset managers and institutional investors are “thinking deeply about how the social interconnectivity of the world has dramatically impacted market correlations and the competitive landscape in which all for-profit enterprises operate.” The firm also points to investors who are hedging the negative consequences of climate change to take advantage of solutions that will stand to gain in a climate-stressed world.  

But despite the heightened popularity of ESG investments, it’s important for advisers and plan sponsors to remember that these funds may serve as advantages in a retirement plan’s investment menu only when they can prove these funds also outperform similar ones based on financial and economic criteria. Taking this into account could further expand ESG into the retirement plan space in 2017.