EDWARD KERSCHNER, CFA
CHIEF PORTFOLIO STRATEGIST
STEVE MO
INVESTMENT STRATEGIST
NEERAJ AGARWAL
INVESTMENT STRATEGIST
INVESTMENT STRATEGY COMMENTARY
WHY ESG? ESG IS A SOLID FRAMEWORK;
CONSIDERING OTHER FACTORS MAY HELP
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Highlights
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The history of ESG investing
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What is ESG?
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The growth of ESG investing
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Environmental, social and governance (ESG) criteria are not part of traditional
financial metrics but can often be measured and may affect the risk and return
of investments. Environmental criteria look at a company’s effect on things like
pollution, climate change, etc. Social criteria consider a company’s relationships
with its employees, suppliers, customers and the communities in which it
operates. Governance deals with a company’s leadership, executive pay, audits
and internal controls, and shareholder rights.
The origin of what is now called ESG — or sustainable, responsible, impact (SRI)
investing — dates back to biblical times. The modern roots of this phenomenon
can be traced to the volatile political climate of the 1960s. In recent years,
aspects of fiduciary responsibility have also come into play.
Interest in ESG investing has seen robust growth. Assets under management
of signatories to the United Nations Principles for Responsible Investment have
grown from $6.5 trillion in 2006 to $62 trillion in 2016, and the number of
signatories has grown from 100 to 1,500.
For investors seeking to access a core portfolio with the added benefit of ESG
criteria, considering other factors (e.g., fundamental screens, such as dividend
income, valuation criteria, etc.) may be beneficial.
The history of ESG investing
The origin of what we now call SRI investing dates back centuries. In biblical
times, laws laid down directives about investing ethically, and including principles
that focused on social justice. These laws also required investors to avoid
businesses involving liquor, pornography, gambling, and banks. In the mid-1700s,
the founder of Methodism, John Wesley, considered the use of money to be the
second most important subject of New Testament teachings.
For generations, religious investors whose traditions embrace peace and
nonviolence have avoided investing in enterprises that profit from products
designed to enslave or harm fellow human beings. It is likely that Methodist and
Quaker immigrants brought the concept of values-based investing to the new
world. The Quakers never condoned investing in slavery or war. Methodists have
been managing money in the United States for over 200 years, using what we
now refer to as ESG integration.
The modern roots of this phenomenon can be traced to the impassioned
political climate of the 1960s. During that tumultuous decade, a series of
themes served to escalate sensitivities to issues of social responsibility and
accountability. Concerns regarding the Vietnam War, civil rights and equality for
women broadened during the 1970s to include labor/management issues and
anti-nuclear convictions. The ranks of responsible investors grew dramatically in
the 1980s as millions of people, churches, universities, cities and states focused
INVESTMENT STRATEGY COMMENTARY
WHY ESG? ESG IS A SOLID FRAMEWORK; CONSIDERING OTHER FACTORS MAY HELP
In recent years, school shootings, human rights, respect for
indigenous peoples around the world, and safe and healthy
working conditions in factories that produce goods for U.S.
consumption have become rallying points for investors with
dual objectives for their investment capital. Most recently,
the climate crisis has awakened investors to opportunities
inherent in directing investment capital toward a truly
sustainable future.1
Exhibit 2: ESG issues considered
Which, if any, of the following ESG Issues do you take into account
in your investment analysis or decisions?
70
60
64
50
50
Percent (%)
investment strategies on pressuring the white minority
government of South Africa to dismantle the racist system
of apartheid. Then, with the Bhopal, Chernobyl, and Exxon
Valdez catastrophes, the environment became top of mind
for socially conscious investors.
49
40
27
30
20
10
0
Governance
Environmental
Social
I do not take
ESG factors
into consideration
Source: Environmental, Social and Governance Issues in Investing, CFA Institute, 2015.
What is ESG?
ESG criteria of companies are not part of traditional financial
metrics but can often be measured and may affect the risk
and return of an investment (see Exhibit 1).
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Environmental criteria measure a company’s effect on
things like climate, pollution, etc.
Social criteria consider a company’s relationships with
its employees, suppliers, customers and the communities
in which it operates.
Governance deals with a company’s leadership, executive
pay, audits and internal controls, and shareholder rights.
Exhibit 1: Examples of ESG issues
Environmental issues
n
limate change and
C
carbon emissions
Social issues
n
n
Customer satisfaction
ata protection
D
and privacy
Governance issues
n
n
A udit committee
structure
n
n
Biodiversity
n
n
Deforestation
n
Energy efficiency
n
Community relations
n
Lobbying
n
Waste management
n
Human rights
n
Political contributions
n
Water scarcity
n
L abor standards
n
Gender and diversity
Employee
engagement
n
n
ESG strategies are quickly evolving in the institutional
investment area, reflecting:3
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Consistent media coverage
Analysis by the Forum for Sustainable Investment4 suggests
that the evolution and growth of ESG/SRI within U.S.
financial markets have been shaped by factors including:
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Bribery and corruption
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Source: Environmental, Social and Governance Issues in Investing, CFA Institute, 2015
A recent study notes that consideration of ESG factors
is becoming more common. Evidence points to a growing
awareness of ESG issues in investing. Only 27% of
respondents said that they do not consider ESG issues.
Thus, 73% consider at least environmental, social or
governance issues, or combinations thereof, in investment
decisions (see Exhibit 2).2
Growing evidence of the financial materiality of responsible
investment
Greater availability of ESG-themed investment strategies
E xecutive
compensation
Whistleblower
schemes
A greater emphasis on ESG for both large U.S. and
European investors
■■
Board composition
A ir and water
pollution
n
The growth of ESG Investing
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Money managers are increasingly incorporating ESG
factors into their investment analysis and portfolio
construction, driven by the demand for ESG investing
products from institutional and individual investors.
Client demand and values were two reasons most
commonly cited by managers — each cited by 72%
of managers.
The incorporation of governance criteria has become a
leading ESG issue for institutional investors and money
managers alike. The most prevalent governance criteria
considered in investment analysis and portfolio construction
include executive pay, board issues, political contributions
and broader policies on corporate governance.
In response to shareholder campaigns for better corporate
governance practices, a growing number of U.S. companies
are establishing more stringent standards for their board
elections and no longer allow their chief executive officers
to chair their boards.
INVESTMENT STRATEGY COMMENTARY
WHY ESG? ESG IS A SOLID FRAMEWORK; CONSIDERING OTHER FACTORS MAY HELP
Interest in ESG investing has seen robust growth. Assets
under management of signatories to the United Nations
Principles for Responsible Investment have grown from $6.5
trillion in 2006 to $62 trillion in 2016, and the number of
signatories has grown from 100 to 1,500 (see Exhibit 3).
The Principles for Responsible Investment (PRI) were
developed by an international group of institutional investors
reflecting the increasing relevance of environmental, social
and corporate governance issues to investment practices.
The process was convened by then-United Nations
Secretary-General Kofi Annan in 2005.
60
1,070
50
719
531
362
263 13 18
100 10
10 6.5
21
1,200
45
1,000
34
800
24
600
400
Assets under management (US$ trillion)
Apr 16
Apr 15
Apr 14
Apr 13
200
Apr 10
Apr 09
0
Apr 08
20
32
Apr 12
30
800
Apr 11
40
1,500
1,380 62 1,600
59
1,400
1,260
1,188
Number of signatories
70
Apr 07
ESG is also evolving to become a part of fiduciary duty.
Lawyers and senior investment professionals concluded
that failing to consider long-term investment value drivers,
which include ESG is a failure of fiduciary duty. While the
law relating to fiduciary duty has changed little in the past
decade, there has been a significant increase in ESG
disclosure requirements. Moreover, the economic and
market environment in which the law is applied has changed
dramatically. Factors such as globalization, population
growth, natural resource scarcity, the internet, social media
and changing community/stakeholder norms all contribute to
the evolution in the relevance of ESG factors to investment
risk and return. This necessarily changes the standards of
conduct required of fiduciaries to satisfy their duties under
the law.5 In 2015, the U.S. Department of Labor released
guidance regarding the ability of retirement plan sponsors
to consider ESG factors in their investment decisions. The
new guidance explains how consideration of ESG criteria is
consistent with the fiduciary responsibilities of investors.
Exhibit 3: PRI signatories
Assets under management and number of signatories
Apr 06
A leading concern for shareholders, especially since the
Supreme Court’s Citizens United decision, is corporate
political spending and lobbying. In 2010, the United States
Supreme Court held that freedom of speech prohibited
the government from restricting independent political
expenditures by corporations, labor unions and other
associations.
Assets under management (U.S. $ trillion)
■■
0
Number of signatories
Source: UN-PRI — April 2016, EGA
While interest in ESG investing has seen robust growth,
understanding the underlying motivations is an ongoing
process:6
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71% of individual investors are interested in sustainable
investing.
54% believe choosing between sustainability and financial
gains is a trade-off.
Compared with the overall individual investor population,
millennial investors are nearly twice as likely to invest in
companies or funds that target specific social or
environmental outcomes.
Female investors are nearly twice as likely as male
investors to consider both rate of return and positive
impact when making an investment.
65% of individual investors expect sustainable investing
to become more prevalent in the next five years.
ESG returns
Although past performance is no indication of future
results, academic research7,8,9,10 has reported that socially
responsible investments historically have performed equal to
conventional investments, with no performance differences.
This research further argues that there may be additional
drawbacks to SRI investing as attractive investments may be
excluded from a portfolio and diversification may be limited.
The net result is that it is likely that SRI funds historically
have not outperformed conventional funds. Positive alphas
from highly rated governance firms have mostly dissipated
in the last decade.11 A similar decline in abnormal returns
INVESTMENT STRATEGY COMMENTARY
WHY ESG? ESG IS A SOLID FRAMEWORK; CONSIDERING OTHER FACTORS MAY HELP
However, a 2015 working paper published by the Harvard
Business School13 used recent guidance by the Sustainability
Accounting Standards Board (SASB) to classify sustainability
topics to material or immaterial according to industry
membership. That study found that firms with superior
performance on material sustainability issues outperform
firms with inferior performance on material sustainability
issues in the future (see Exhibit 4.)
HIGH
LOW
Performance on Material Factors
Exhibit 4: Stock returns by type of sustainability performance
Annualized alpha, April 1993 to December 2013
6.01%
1.96%
-2.90 %
0.60%
LOW
HIGH
Exhibit 5: MSCI World and ESG indices
09/28/07–06/30/16
160
Total return index (gross)
seems to have occurred for the social dimension of SRI
favored firms.12 Thus, it appears that an expectation of
positive alphas from investing in SRI stocks is not likely
to form the economic motivation for institutional investors’
portfolio choices.
129.3
140
120
128.2
100
80
60
40
20
0
2007 2008 2009 2010 2011 2012 2013 2014 2015 2016
MSCI World ESG Gross Return Index
MSCI World Gross Return Index
Source: MSCI, Bloomberg, EGA. Indexed, 09/28/07=100, Data as of 06/30/16.
Past performance does not guarantee future results. It is not possible to invest
directly in an index.
ESG is a solid framework; considering other factors may help
The good news is that ESG investors, regardless of motivating
factor, can implement ESG criteria as a core portfolio holding.
For investors seeking to access a core portfolio with the
potential benefit of ESG criteria, considering other factors
(e.g., fundamental screens, such as dividend income,
valuation criteria, etc.) may be beneficial.
Performance on Immaterial Factors
Source: Corporate Sustainability: First Evidence on Materiality, Mozaffar Khan, George
Serafeim, Aaron Yoon, Working Paper 15-073, Harvard Business School (2015).
The MSCI World ESG Index is a capitalization-weighted
index that provides exposure to companies with high ESG
performance relative to their sector peers. Since inception,
its performance has virtually mirrored the MSCI World Index,
a free float-adjusted market capitalization weighted index
that is designed to measure the equity market performance
of developed markets (see Exhibit 5). From its inception in
2007 through June 30, 2016, the MSCI World ESG Gross
Return Index has had a total return of 29.3% vs. 28.2% for
the MSCI World Gross Return Index.
Conclusion
The criteria on which ESG rates companies — pollution;
climate change; relationships with employees, suppliers,
customers and communities; leadership; executive pay;
audits; internal controls; and shareholder rights — are
not part of traditional financial metrics but can often be
measured and may affect the risk and return of investments.
Interest in ESG investing has seen robust growth. Assets
under management of signatories to the United Nations
Principles for Responsible Investment have grown from
$6.5 trillion in 2006 to $62 trillion in 2016 and the number
of signatories has grown from 100 to 1,500. While there
remains debate about the returns associated with the
implementation of ESG criteria, initial data suggested that
investors, regardless of motivating factor, could implement
ESG criteria as a core portfolio holding, without any
performance penalty or benefit. More recent studies have
skewed to the positive as ESG investing techniques have
advanced and data has improved. For investors seeking to
access a core portfolio with the added benefit of ESG criteria,
considering other factors (e.g., fundamental screens, such as
dividend income, valuation criteria, etc.) may be beneficial.
INVESTMENT STRATEGY COMMENTARY
WHY ESG? ESG IS A SOLID FRAMEWORK; CONSIDERING OTHER FACTORS MAY HELP
To find out more, call 800.426.3750
or visit columbiathreadneedle.com/us
The SRI Conference on Sustainable Responsible Impact Investing, http://www.sriconference.com/about/what-is-sri/history-of-sri.html
Social and Governance Issues in Investing, CFA Institute, 2015
3
Responsible Investment, Columbia Threadneedle Investment Advisers, LLC, 2016
4
Sustainable and Responsible Investing Trends in the United States, The Forum for Sustainable Investment, 2012
5
Principles for Responsible Investment, United Nations Environment Programme Finance Initiative and United Nations Global Compact, Fiduciary Duty in the 21st Century (2015)
6
The Morgan Stanley Institute for Sustainable Investing, February 2015
7
Ethical requirement and financial interest: a literature review on socially responsible investing, Business Research, October 2015, Volume 8, Issue 1, Miriam von Wallis, Christian Klein
8
Institutional Investors and Socially Responsible Investments: It Just Makes (Economic) Sense, January 2016: Hamilton, Jo, and Statman, 1993; Statman, 2000, 2006
9
Institutional Investors and Socially Responsible Investments: It Just Makes (Economic) Sense, January 2016: Borgers, et al., 2015; Nofsinger and Varma, 2014; Adler and Kritzman, 2008
10
Institutional Investors and Socially Responsible Investments: It Just Makes (Economic) Sense, January 2016: Renneboog, Horst, and Zhang, 2008a; Bauer et al., 2005
11
Institutional Investors and Socially Responsible Investments: It Just Makes (Economic) Sense, January 2016: Bebchuk et al., (2011)
12
Institutional Investors and Socially Responsible Investments: It Just Makes (Economic) Sense, January 2016: Derwall, et al., (2011)
13
Corporate Sustainability: First Evidence on Materiality, Mozaffar Khan, George Serafeim, Aaron Yoon, Working Paper 15-073, Harvard Business School (2015)
Edward Kerschner, CFA is a registered representative of ALPS Distributors, Inc.
Past performance does not guarantee future results.
There are risks involved with investing in Exchange Traded Funds (ETFs), including the loss of your investment. One cannot invest directly in an index.
The views expressed are as of the date given, may change as market or other conditions change, and may differ from views expressed by other Columbia Management Investment Advisers,
LLC (CMIA) associates or affiliates. Actual investments or investment decisions made by CMIA and its affiliates, whether for its own account or on behalf of clients, will not necessarily
reflect the views expressed. This information is not intended to provide investment advice and does not account for individual investor circumstances. Investment decisions should always
be made based on an investor’s specific financial needs, objectives, goals, time horizon, and risk tolerance. Asset classes described may not be suitable for all investors. Past performance
does not guarantee future results and no forecast should be considered a guarantee either. Since economic and market conditions change frequently, there can be no assurance that the
trends described here will continue or that the forecasts are accurate.
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