(Editor's Note: S&P Global convenes its Academic Council, comprising a group of scholars from top universities, biannually to discuss economic and market-related topics of mutual interest. This commentary reflects some of the views developed during the most recent meeting, on Oct. 11, 2019.)
NEW YORK (S&P Global Ratings) Oct. 31, 2019--Once a niche investment proposition relegated to the sidelines of finance, ESG-influenced investing has moved to the mainstream as more and more companies and asset managers realize that sustainable practices can make for sustainable returns. In this light, more than 100 conventional funds added ESG to their prospectuses in the first half of this year, according to one member of the S&P Global Academic Council--a practice that has growth potential, given that 84% of millennials and 70% of women say they consider ESG when investing.
Moreover, as corporate managements take steps to mitigate the risks of climate change their firms face, a number of studies show that the more companies embed these goals in their growth strategies, the better they perform at individual and portfolio levels, some council members suggested.
When companies pay greater heed to environmental, social, and governance practices, it can improve competitiveness in a number of ways, one council member said, including differentiating them from competitors, fostering innovation and preventing knowledge spillovers, and enhancing employee governance. It can also help sustain competitiveness during economic crises and affect shareholders' perception and returns.
"Companies that do indeed adopt a longer time horizon experience an increase in shareholder value," the council member said, adding that the effect is stronger for companies with more exposure.
While this view lacked unanimity among council members, it's clear that financial markets have entered a new phase in which sustainability isn't just about highlighting the actions of good companies, but rather an era in which investors integrate ESG into their portfolios. Evidence that they can do so without losing performance can be seen in a comparison between the benchmark S&P 500 and the new S&P 500 ESG--a broad-based index with similar industry group weighting as the S&P 500 but designed to measure the performance of securities meeting sustainability criteria. In the five years from Sept. 30, 2014, to Sept. 30, 2019, the two indices posted nearly identical returns.
To be sure, ESG funds are still small compared with mainstream funds, and, according to one council member, 60% of financial advisers are skeptical of ESG investing. At the same time, many investors are arguably allocating funds to companies and portfolios that score well on ESG assessments not for moral reasons, but rather for the risk-adjusted returns they generate.
Either way, socially responsible investing has been around for nearly a century, one council member said, citing one fund that began in 1928 with guidelines that prevented it from holding shares in companies in the tobacco, alcohol, and gambling industries. In more recent history, the College Retirement Equities Fund (CREF) began its Social Choice Account in 1990, and assets reached $1 billion just five years later.
S&P Global, too, has had a long-standing commitment to finding sustainable-finance solutions--an effort that stretches back at least two decades with the introduction of the Dow Jones Sustainability Indices (DJSI). Developed in collaboration with ESG data firm RobecoSAM, S&P Dow Jones Indices launched the DJSI World in 1999--the first global index to track the largest and leading sustainability-driven public companies, and now the global standard for measuring and advancing corporate ESG practices.
Some council members questioned the direction of causality between a company's ESG practices and its competitiveness, suggesting that there may be a self-fulfilling prophecy in that healthy firms invest more in ESG. Another member questioned the idea that millennials (those born in the early 1980s through 2000) are more or less universally aligned in their beliefs and values.
"I think they're as diverse politically as any generation," the council member said, adding that the recent push for companies to be more responsive to stakeholders (employees, the broader community, etc.) rather than just shareholders (as Nobel Laureate economist Milton Friedman suggested) is misguided. "If there is no company in the end, we all lose."
One council member suggested that ESG was being used as just one input into wealth generation--perhaps acting best as a tiebreaker in asset-allocation decisions. In any case, the council member said that investors have "completely underappreciated the risk of transition" with regard to the companies' physical risks of climate change. The council member used the analogy of a cyclist approaching a blind curve while descending a winding mountain road: The most prudent option, of course, is to slow down before reaching the curve, lest the cyclist encounter a fallen tree, an approaching truck that has crossed the center line, or, in the worst case, find that the road has completely disappeared.
Certainly, extreme weather events are taking a greater toll on the world's infrastructure and economic productivity. Adjusting to this will carry challenges and opportunities, and industries and communities that are especially exposed could face lower costs if there is an early and orderly transition.
Either way, climate change is at the heart of financial stability, one council member said, adding that equity funds have traditionally had a much faster adoption rate of ESG factors than fixed-income funds. And while ESG funds are still small compared with mainstream funds, the drive toward sustainable finance may be on the verge of a breakthrough. Global sales of green bonds--used to finance everything from sustainable agriculture to clean transportation projects--have this year already exceeded last year's record $135 billion, with sovereigns (particularly European countries) driving the market. Other estimates put the market even higher, at more than $167 billion last year, up from just $13 billion five years earlier. And issuance in the Asia-Pacific region is catching up to Europe, thanks to China, the council member said.
Still, challenges remain. Corporate reporting on ESG is limited and lacks standardization, one council member said. To combat this, many firms are seeking greater clarity and confidence in investors' ability to accurately price long-term ESG risks and opportunities, and developing internationally accepted disclosure principles and ESG performance indicators would go a long way.
Writer: Joe Maguire
This report does not constitute a rating action.
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