Why ESG reporting still matters to U.S. investors
Based on conversations BSR has had with investors and finance industry partners, companies should know that a change of administration in Washington will not affect the fundamental trends driving environmental, social and governance (ESG) investing. In the short term, businesses may face even more pressure to focus on ESG: As environmental and social regulation may decrease in the next four years, activists, including responsible investors, are likely to increase calls for voluntary initiatives.
When using an ESG investment approach to portfolio selection and management, an investor takes into account a company’s practices and policies related to issues such as climate change, biodiversity or human rights in the supply chain. Sustainable or responsible investing are also commonly used terms for this approach. ESG investing encompasses a number of investment strategies, such as excluding certain companies or sectors, picking top performers within a sector, integrating ESG factors alongside financial factors, or engaging companies on ESG issues and leading shareholder action.
Despite the tumultuous geopolitical events of 2016, in the medium-to-long term, four underlying fundamental trends remain unchanged, which means that ESG investing will continue to grow globally.
First, ESG investing continues to move from niche to mainstream. According to the US SIF 2016 (PDF) report, ESG investing represented $8.72 trillion, or one-fifth of all investment under professional management in the United States this year, an increase of 33 percent since 2014. The Global Sustainable Investment Alliance estimates that ESG investing represents a third of assets under management globally (PDF).
Second, ESG investing is client-driven — leading asset owners require their asset managers to consider ESG factors because it’s good for long-term returns. In its investment policy, the pension fund California Public Employees' Retirement System states: "Strong governance, along with effective management of environmental and human capital factors, increases the likelihood that companies will perform over the long term and manage risk effectively." That includes fair labor practices, climate change and natural resource availability.
Third, much of ESG investing is driven by European investors that invest globally, and U.S. companies will continue to face the same pressure from their European investors. According to Morningstar, Europe has twice as many assets in ESG investments as the United States. For instance, major asset owners such as the Government Pension Fund of Norway and French insurance company AXA have divested from coal, and the Dutch pension funds PGGM and ABP have set targets to invest $60.56 billion in investments that support the Sustainable Development Goals.
And finally, ESG investing related to climate change will persist. At Goldman Sachs’ Low-Carbon Economy Global Forum on Nov. 30, Jim Barry, global head of BlackRock Infrastructure Investment Group, argued that the incoming U.S. administration "will do nothing to slow down the penetration [of renewables] because raw economics are changing the game" — not regulation.
Responsible investors are trying to understand how the incoming U.S. administration will affect ESG investing. A few things may happen in the next four years.
In terms of total assets, ESG investments likely will continue to grow due to overall growth in the equity market. In anticipation of reduced regulation and taxes, the equity market has responded well since the November election.
ESG investments may encounter a dip in returns in the short term. Recent studies have found that ESG investing outperforms markets, but this may not be as true in the next four years. As decreased regulation may benefit certain industries, such as fossil fuels, and damage others, such as renewable energy, ESG investment returns may not do as well against benchmark returns. Investors may be pressured to abandon ESG investment strategies, such as portfolio decarbonizing or green funds, if returns suffer.
Companies are likely to face more pressure from responsible investors in the next four years. Lisa Woll, CEO of US SIF, said that the election could spur more responsible investing, as environmental impacts may not be addressed on a governmental level. In the wake of the election, responsible investor Trillium stated: "With the election of Donald Trump, our work becomes more important than ever. In the face of weakening or dismantling of agencies such as the Environmental Protection Agency, we will need to further strengthen our multi-pronged interactions with investors, communities, corporations and policymakers to address the world’s pressing social and environmental problems."
Investors and companies have opportunities to engage the new administration on the sustainability agenda — such as green infrastructure. The Principles for Responsible Investment argue that investors should seize this window of opportunity to engage the administration by emphasizing the business case of adding a sustainability focus to U.S. infrastructure projects.
The underlying business case for ESG investment is that good sustainability management is a proxy for good management overall and ensures improved long-term performance of a company. Therefore, it will benefit any smart investor, even in the absence of environmental and social regulation, to pay more attention to how a company integrates sustainability into its strategic decisions, regardless of political changes in the United States or around the world.
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