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August 5th, 2019
By Mark Bell
ESG (environmental, social, and governance) investing is fast becoming one of the biggest trends among both institutional and individual investors today. It seems to be something everyone is talking about, and many want to incorporate ESG strategies into their portfolios. But what exactly does ESG mean? And how should ESG-related investing decisions be implemented? These are topics discussed in a recent webinar on ESG we hosted in conjunction with Natixis Investment Managers.
There are still many misconceptions around ESG, as some still view it simply as a “feel good filter” to be added on to their portfolios. But there’s so much more to consider when it comes to ESG, and those that are seriously looking at it as an investment strategy are grappling with issues such as how it delivers on performance perceptions and how to create accurate reporting around it.
What’s clear is that it’s only going to become more entrenched in the investment world. According to a Natixis survey, 65% of institutional investors say ESG will become a standard practice in the next five years for all managers. And as it evolves, there is now a trend towards a more sound investment thesis around ESG.
It’s not just about pursuing your societal values but aligning performance with those values. While the majority of investors say it is important to consider social and environmental values when choosing where to invest their money, they won’t do it at the expense of performance. If there is a sense that an ESG portfolio is underperforming compared to the broader market, there will be concerns and questions raised about the strategy.
That’s why it’s essential for ESG strategies to be actively monitored and managed; it’s not a “Set it and forget it” kind of investing decision. ESG factors should be incorporated into a firm’s fundamental analysis to pursue alpha. Natixis’ survey of investment managers found that about 75% of respondents believe alpha is harder to find now more than ever. ESG can be a new source for finding alpha, as long as:
It should also be noted that ESG funds can help mitigate against headline risk. A recent example of this was the claims that the herbicide Roundup can cause cancer; this became a major concern and issue for all shareholders of its parent company, Monsanto. In addition to pursuing alpha, mitigating risk can be a significant reason to implement ESG strategies. High ESG-rated companies may be better at managing company-specific and operational risks, resulting in a lower probability of suffering incidents that can impact their share price.
When it comes to reporting, there is a notion that there is an “information gap” when it comes to ESG. There can be some truth to this, but it is also a bit of a perceived roadblock, as more and more reporting tools have come on the market from vendors like Bloomberg and Thomson Reuters as well as sustainability ratings such as Morningstar’s “sustainalytics” index, that can help measure the performance of ESG investing. To be most effective, ESG funds need to show robust reporting on standard investment returns – as well as their progress against their sustainability goals.
Ultimately, it takes significant investment expertise, in-depth analysis, and highly active portfolio management to do ESG right. It’s not something to be lightly considered or half-heartedly undertaken. Many firms seeking to introduce ESG funds build their own in-house teams, while others look to OCIO and third-party management consultants for their expertise. However you go about it, ESG is on its way to becoming an industry standard, and firms should take into account how to fully integrate it into the investment process before jumping in.
For more information, watch our on-demand webinar with Natixis Investment Management which discusses the latest trends in ESG investing.
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