Sustainability has reached the status of a "megatrend" in recent years. A survey of asset managers conducted by Harvard Business School showed that more than 80% now consider ESG when making investment decisions.
As more companies take sustainability into account in their decision making, investors must also consider sustainability in theirs. The systematic consideration of environmental, social, and corporate governance, or ESG, factors within the investment process is how investors are doing that.
But that straightforward-sounding definition belies a variety of approaches being taken to sustainable investing.
One big misconception is that asset managers are paying attention to ESG simply because of growing client demand. But most asset managers who said they now consider ESG information when making investment decisions indicated they were doing so because they believe that information improves investment performance. The following are some of the broad approaches:
ESG Aware
In ESG-aware strategies, asset managers make ESG data and analytics available to their analysts and portfolio managers, but how the latter use the information is up to them. Managers use the information to varying degrees in their investment process.
As more asset managers make ESG data and analytics available to their firms and as analyst teams use it to inform their work, the number of ESG-aware strategies will continue to increase
ESG Incorporation
Similar to ESG aware, an ESG-incorporation strategy considers ESG as necessary for a more complete investment analysis but it’s just one set of criteria among many that may be relevant to an investment decision. An ESG-incorporation strategy goes a step further by explicitly including ESG criteria as part of its investment process. This higher level of commitment to ESG is reflected in a strategy’s fund prospectus or statement of investment objectives.
ESG Outcome
A strategy seeking an ESG outcome is one in which ESG considerations play a bigger role in the investment process, resulting in a portfolio of companies with better sustainability profiles. The typical ESG-outcome portfolio is tilted toward such companies and generally excludes or underweights companies with poor sustainability profiles.
ESG-outcome funds can also be actively managed and may include traditional financial criteria. It isn’t uncommon for these funds to use some of the traditional exclusionary screens – such as tobacco and guns. Most of these funds use key terms like “ESG” or “sustainable” in their names.
ESG Impact
An ESG-impact strategy is similar to an ESG-outcome strategy, but in addition to its focus on financial outcomes, it also attempts to deliver a positive societal or environmental impact. The portfolios of impact strategies may look like those of ESG-outcome strategies, but they also include “active ownership” activities, such as ongoing engagement with companies about ESG issues and a willingness to sponsor and vote in favour of ESG-related shareholder resolutions.
ESG Strategies Will Keep Growing
As ESG becomes a more common element of most asset managers’ investment process, the number of ESG-aware and ESG-incorporation strategies will keep growing, and more investors will have ESG integrated into their portfolios. Including sustainability evaluations will just become part of what it means to invest. For those who want to achieve impact alongside financial return with their investments, the number of ESG-impact strategies will continue to grow.
