This In Practice piece gives a practitioner’s perspective on the article “Why and How Investors Use ESG Information: Evidence from a Global Survey,” by Amir Amel-Zadeh and George Serafeim, published in the Third Quarter 2018 issue of the Financial Analysts Journal.
What’s the Investment Issue?
The number of companies worldwide that report environmental, social, and governance (ESG) data has grown exponentially over recent years, from fewer than 20 in the early 1990s to almost 9,000 in 2016. Investor interest in ESG data has also grown rapidly. For example, as of 2016 the UN Principles for Responsible Investment had about 1,400 signatories, with assets under management (AUM) of about $60 trillion. It has been shown that companies’ disclosure of ESG information is related to economically meaningful effects, such as lower costs of capital and out performance of benchmarks. Less is known about how and why investors use ESG data and the challenges they face in doing so. While many other surveys look at the motivations of specifically ESG-focused investors, this study’s authors set out to capture broader views of mainstream investment professionals.
How Do the Authors Tackle the Issues?
The authors drafted an online survey and distributed it to a list of senior global investment professionals compiled by the Bank of New York Mellon and Ipreo. From January to April 2016, the survey received 652 responses. Two-thirds of respondents worked for professional asset managers, and the remainder worked at asset owners such as pension funds, financial institutions, and charities. Most of these respondents can be considered mainstream investors because almost 70% reported that less than a tenth of their AUM was allocated to ESG. Combined, the respondents’ AUM was roughly $31 trillion—about 43% of the global total at the time.
Respondents were asked the following multiple-choice questions, each with 7–10 answer options:
- What motivates investors to use ESG data?
- What barriers do they face to using ESG data in the investment decision process?
- How do they use ESG data in their investment process, if at all?
- How important will these strategies be in their investment process over the next five years, on a scale from 1 (least) to 3 (most)?
They were also asked to rate the expected impact of different ESG investment strategies on performance, on a scale from 1 (worst) to 5 (best). The authors tabulated the results, drawing distinctions between large and small investors (with AUM > $5 billion and AUM < $5 billion, respectively) and those from the United States and Europe (who together make up three quarters of respondents). They then ran regressions, exploring the motivations for favouring different ESG styles and determinants of their future importance.
What Are the Findings?
By far the most widespread reason for using ESG information in investment decisions, flagged by 63% of respondents, is that it is material to investment performance. By contrast, 33% said it is an ethical responsibility—about the same number who cited growing client demand and product strategy.
The leading barrier to ESG integration is a lack of comparability across firms. Other impediments are a lack of standards in reporting ESG information and the cost of gathering and analysing the data.
The most popular ESG investment strategy used by respondents is engagement/active ownership—that is, the use of shareholder power to influence corporate behavior. It is followed by full integration into individual stock valuation, which means explicitly including ESG factors in the financial analysis of equities. These are also the two strategies expected to have the most positive impact on performance, which is unsurprising given respondents’ motivations for using ESG data. In fact, all but one of the investment styles surveyed are thought to have a markedly positive impact on returns, the exception being negative screening (which was neutral).
Respondents said that, over the next five years, among their most important investment strategies are positive and negative screening—that is, the inclusion or exclusion of companies from an investment portfolio based on their sector, practices, or other ESG criteria. Active ownership and full integration into individual stock valuation will also continue to be important. Portfolio tilt—using certain investment strategies to tilt the ESG characteristics of a fund to a desired level—is considered by far the least important future strategy.
A key finding from the regressions the authors ran on the data is that financially motivated investors prefer different ESG investment styles from those who are ethically motivated. The former are significantly more likely to use an integration strategy than the latter, whereas ethical motivations are linked with a higher likelihood of negative and positive screening.
What Are the Implications for Investors and Investment Professionals?
One finding likely to be of interest to investment professionals is that the ESG investment strategies surveyed are generally expected to have a markedly positive impact on financial returns. This might explain why a large majority of their peers are using ESG data, even if they are not motivated primarily by ethical responsibility. Another finding of interest is that while investors continue to see active ownership and full integration as important strategies over the next five years, they also expect to put more emphasis on positive and negative screening than they do currently.
Future practices, the authors observe, are more likely to be driven by the materiality of investors’ actions—both in terms of the impact of these actions on returns and their effectiveness in bringing about change. They say that a next step is developing measures of these various investment strategies to understand their consequences for investment performance.