Dr. James Hawley

Head, ESG Research, TruValue Labs

A TruValue Labs colleague of mine (Isaac Khurgel) wrote a blog piece appropriately titled: “To ESG or not to ESG – no longer a question”. His main point: ESG/sustainability/responsible investment (RI) activities (I use these terms interchangeably) among various sectors of the investment community in the U.S. (and certainly in the U.K. and Europe, indeed, increasingly globally, e.g. China) have become expected and indeed perhaps normative. Though a large question remains: how much of this is just talk, and how much of it is borne out by actual action?

For some investment firms (small, large and giant) there is some walk to the talk. For too many it is still talk (or at best a leisurely and ambling walk), for example, through the development of a series of ESG investment ‘products’ and a bare bones corporate governance ‘team’. Beyond the verbal and what might even be called the ghettoization of ESG within many very large investment institutions, there is some movement toward ‘ESG integration.’ For example, engagement with firms on some ESG issues – though not always followed through in proxy voting, or perhaps the engagement is focused on what some might consider a more peripheral ESG issue.

The very success of the ESG talk is a welcomed and very important change from even three years ago; it changes the agenda even as it comes to mean different things to various actors on the responsible investment stage. [1]

“The very success of the ESG talk is a welcomed and very important change from even three years ago…”

In the U.S. in particular a there has been a remarkably quick shift in putting RI/ESG on the agenda among most of the largest financial institutions (with parallel developments among many corporates talking the sustainability talk, and, again, some even doing some of the walking). On the financial side, money managers (e.g. Vanguard, BlackRock), some hedge funds and private equity firms, and banks (e.g. Citigroup) have adopted (some very recently, some 3-5 years ago) a form of taking ESG/RI ‘into account’ or ‘integrating ESG’. The forms vary widely from active governance engagement, to taking ESG ‘into account’ by portfolio managers, to developing in-house ESG products and/or investment strategies, and to ESG integration (although that, too, means very different things to different investors).

Among the most important drivers of these quite dramatic changes is the increasing consumer demand for ESG products (doubling from 2012-14 alone to about $6.75 trillion); pressures from various stakeholder groups (not unrelated to consumer demand); increasing evidence that high ‘sustainability’ indicators used to evaluate corporate behavior often have led to corporate equity out-performance and/or lower capital (debt) costs, as well as correlation with efficiencies in key operational measures (e.g. ROA, ROE). Additionally, there are concerns that regarding some issues – most of all climate change – that the current direction and momentum of the financial system is simple not sustainable for maintaining long-term portfolio value as a whole (a universal owner type perspective which accounts for the portfolio’s internalization of externalities).

“Among the most important drivers of these quite dramatic changes is the increasing consumer demand for ESG products…”

Underscoring these developments in the private sector, the Department of Labor (DOL) issued an Interpretive Bulletin [2] on October 26 (2015) which eliminates fiduciary duty uncertainty about whether ESG factors and economically targeted Investments (ETIs) can be considered in the investment process. This is extremely important in ESG’s progression, as the question now becomes a specific one: are there ESG factors which are or may be material in a particular investment, and if so, it is the fiduciary obligation to undertake due diligence as to the economic and value consequences of competitive investment choices. The DOL’s interpretation underscores and raises the importance of SASB (Sustainability Accounting Standards Board) and other reporting initiatives while also putting on the agenda which ESG issues are likely to become ‘material’ to investors, and whether that implies the next stage will be that the SEC should mandate material disclosure. [3]

What these developments share and what mainstream investors increasingly recognize is that ESG factors are potentially or actually material and are thus becoming increasingly integrated into investment processes in some form.

“Mainstream investors increasingly recognize… that ESG factors are potentially or actually material…”

However, efforts at fully incorporating ESG risks and opportunities are far from universal, especially from an internal organizational perspective. Challenges include varying approaches to the different E, S, and G “thematic silos” and strategies that differ, necessarily or otherwise, by asset class. This can lead to potential internal conflicts regarding different strategies and effectiveness. For example, investments in and activities by some private equity and hedge funds in one ESG category may result in support of activities that are contradictory to engagement activity in the equity sector.

As both the ‘talk’ and the ‘walk’ continue to develop there are as least three major challenges I see that confront sustainable investing and corporate behavior. These are:

  • The relation between RI and stewardship;
  • The relation between RI and the problem of ‘short termism’ (of financial markets and of much corporate investment planning, perhaps in perceived response to and pressure from financial markets), and;
  • The relation of RI to the challenges of systemic risk, in particular, climate change and financial crisis.

In this light Raj Tharmotheram and Helen Wildsmith suggest that ESG/RI as a capital allocation strategy is perhaps less important than what they call ‘forceful stewardship’ by long-term owners. [4] The first point regarding capital allocation strategy is based on the Kay report’s argument that internal corporate investment allocation is more important regarding climate change (for example), then external investors’ capital. [5] Their second point about forceful stewardship which they define as “… the willingness to vote for resolutions which address systemic risk while protecting long-term shareholder value…To be clear, this is not about doing good. Rather, it is about discharging fiduciary duty, given the new understanding of a major systemic risk [such as climate change and financial crisis].”

The remarkably rapid and increasingly widespread move to incorporate ESG in some form is a welcomed process. Going forward this acceptance raises a series of challenges which will be discussed in future posts. Among those that are critical are:

  • What does taking ESG factors into account or integrating them, mean? What is the range of actions these relative newcomers to and long time residence in RI space are undertaking? What are their strengths and weaknesses?
  • How do we evaluate the likely impact on firm behavior of this range of actions?
  • Who is leading whom? Are investors (some, a few, most?) leading corporate behavior (CSR-corporate social responsibility), or are (some, a few, most?) corporates ahead or at least on pace with investors their CSR or sustainability programs, actions and plans?

To adopt the idea from the early millennial fictive character Buzz Lightyear, whose hallmark quote was “To Infinity and Beyond”, it is now time to look “To ESG and Beyond”.

[1] Some varied examples of trends and evidence:














[2] https://s3.amazonaws.com/public-inspection.federalregister.gov/2015-27146.pdf “An important purpose of this Interpretive Bulletin is to clarify that plan fiduciaries should appropriately consider factors that potentially influence risk and return. Environmental, social, and governance issues may have a direct relationship to the economic value of the plan’s investment. In these instances, such issues are not merely collateral considerations or tie-breakers, but rather are proper components of the fiduciary’s primary analysis of the economic merits of competing investment choices.”

[3] I am indebted to Keith Johnson for this interpretation of the Bulletin.

[4] Raj Thamotheram and Helen Wildsmith, ‘Long-Term Matters” Investment and Pensions Europe. Available at: http://www.ipe.com/analysis/long-term-matters/long-term-matters-call-to-voting-advisers/10009982.article

[5] ‘The Kay Review of UK Equity Markets and Long-Term Decision Making’, available at: https://www.gov.uk/government/uploads/system/uploads/attachment_data/file/253454/bis-12-917-kay-review-of-equity-markets-final-report.pdf