What sparked today's love of ESG?

Ten years ago, when Casey Clark was planning to focus his career on the ESG investing space, he was discouraged by friends and colleagues who described the move as a career killer and dead end.

Today, the global head of environmental, social and governance investments at Rockefeller Asset Management can’t keep up with the LinkedIn requests and people wanting to talk about ESG investing.

“I almost feel like I’m in a different world from only a few years ago, when it felt very risky to get into this space,” Clark said.

He acknowledges that he can’t point to a single thing that pushed ESG investing popularity over the top, but said the momentum is palpable. “It was a confluence of events, including the demand from a new generation of investors, Covid-19 and the realization that this ESG information can be used to generate alpha.”

Clark’s impressive decade of experience in the ESG space actually pales in comparison to a handful of companies and individuals who blazed the trail even before the asset management industry had enough structure or nomenclature to make ESG an official category. At Calvert Research & Management, Domini Impact Investments and other firms that were pioneers, the sudden popular appeal is both real and alarming.

“Right now, ESG is the hottest thing out there, but we’re definitely not clapping our hands and saying, ‘We told you so,’” said John Streur, CEO of Calvert Research & Management, which has been focused on sustainable investing since its founding 45 years ago.

“I think we just reached a point at which the actual problems associated with companies not doing a good job for the environment, people and society reached a critical mass where people can see that we have real problems that can destabilize the system,” Streur said. “Even though we have lots of asset managers now saying they do ESG, the clients are still very much in charge, because they continue to ask for higher standards, more shareholder engagement, and more activism. At the end of the day, this is about changes clients want to see in society and in asset management.”

At the same time, a new Cerulli report suggests financial advisers may not appreciate the appetite their retail clients have for ESG investing.

Advisers tend to describe demand for ESG as coming from “a handful” of clients, mostly high net worth. However, Cerulli’s research finds 56% of households with $100,000 to $250,000 to invest would prefer to support companies with positive ESG impact. 

The stunning asset flows into funds also indicate that investing based on ESG criteria is not a fleeting trend. 

According to Morningstar, money flowing into U.S. funds categorized as sustainable hit a record $51.1 billion in 2020, more than double the 2019 record of $21.4 billion, a third of which came in during the fourth quarter of that year.

For context, the annual flows into sustainable funds had been hovering around $5 billion from six years ago through 2018. In 2011 and 2012, sustainable fund flows were negative.

“My view is that this is starting on the demand side, with more people having sustainable concerns today than ever before,” said Jon Hale, Morningstar’s head of sustainable investing research.

“During the past two years, we’ve had so many in-your-face climate events,” he added. “People forget that at the beginning of last year Australia was on fire, and then the pandemic has also increased the focus on this.”

PUSHED BY THE PANDEMIC

The correlation between the global pandemic and the popularity of ESG investing is undeniable.

Following the $7 billion spike in the fourth quarter of 2019 in flows into sustainable funds, flows hovered around $10 billion in the first three quarters of 2020 before jumping above $20 billion during the final three months of the year.

“If there’s a silver lining to a pandemic like this, it is that it has reinforced the importance of ESG investing and brought attention to the social aspects of it,” said Ana Carolina Oliveira, head of sustainable finance at ING Americas.

“ESG is not on the back burner anymore; it’s all the way front and center,” Oliveira said. “And social is a definite winner because you can’t just take out high-polluting industries without taking care of employees. These three letters, ESG, need to be walking together otherwise we would not be achieving success for our society.”

In an April report exploring the state of sustainable investing on a global scale, ING describes 2020 as a “wake-up call.” It found that “even as the pandemic has created financial upheaval for companies,” 57% of companies say they are “accelerating green transformation plans.”

In addition, 73% of companies globally that have issued sustainable finance instruments said it has improved their ability to put in place “robust internal accountability metrics.”

If Covid-19 was the tipping point for ESG catching fire, the pressure had been slowly but steadily building for years, said Allyson McDonald, CEO of Boston Common Asset Management, a company she described as “doing ESG before it was cool.”

In terms of factors driving the appeal of ESG investing, McDonald cited the shift of wealth from baby boomers to millennials, “because millennials expect more from companies and the products and services they offer in the marketplace.”

“Another influential factor is the growing number of women investors,” she said. “Women are largely focused on investing in high-quality portfolios of companies whose products and services provide solutions to environmental and social challenges.”

Finally, as many of the sustainable funds that avoided the energy sector recently illustrated, ESG investing can no longer be saddled with the criticism that it creates a drag on performance.

“Increasingly, investors recognize the opportunity for ESG investments to generate outperformance,” McDonald said. “Evaluating companies with consideration for ESG risks and opportunities results in high-quality portfolios built to withstand volatile markets and economic conditions.”

Even for many of the earliest proponents of sustainable investing, the sudden spike in popularity and notoriety is surprising, but satisfyingly so.

“The increased competition helps us in a big way because it gives us something to compete with and it validates the thesis,” Calvert’s Streur said. “It also saves us time from having to explain ESG as often.”

ESG IS NOW A MUST-HAVE

Alexandra Mihailescu Cichon, executive vice president in sales and marketing at the ESG data science firm RepRisk, said that in the more than 10 years she has worked in the area, she has “never seen the interest accelerate to the level it has over the past 12 to 18 months.”

“If you’re an investment manager without ESG, you will soon have trouble attracting assets from clients because it has moved from a nice-to-have to a must-have,” she said. “Three to five years ago, the discussions were all about why and prove it, but now companies are asking how they can do it.”

Cichon is also in the camp that doesn’t think the growth spurt occurring at the same time as Covid-19 is just a coincidence. 

“We may look back at 2020 as the turning point for ESG, and Covid was that turning point because somehow when the pandemic started people thought it would slow down the appeal of ESG, but instead people saw the interconnectivity between what’s happening in our society and the global implications,” she said. “Covid helped to elevate the S in ESG.”

For patience and perspective, there are probably few who could stand alongside Amy Domini, who started paying attention to sustainable investing in the late 1970s when, as a stockbroker, she noticed some of her clients expressing social and ethical aversions to owning certain companies.

At a time of increasing awareness of apartheid in South Africa, which supported institutionalized racial discrimination, Domini started to cater to the specific passions of some clients.

“I didn’t want to make a client mad and lose them, so I started asking questions and realized that everybody had lines they didn’t want to cross,” she said.

ESTABLISHING GUIDELINES

What followed, while Domini authored or co-authored six books on ethical investing, was the establishment of KLD Research & Analytics, along with the Domini Social Index, now called the MSCI KLD 400 Social Index, which helped spur investing that meets ESG guidelines.

Domini, who is retired but still chairman of the board of Domini Impact Investments, describes her feelings about the current rise in ESG investing popularity as “beyond thrilling.”

“I kind of figured I’d be an important pinprick in the history of ESG investing, but now I’m living long enough to see this become the way investing is done,” she said. “Finance is global, sophisticated, it can turn on a dime, and it has good data. You can’t imagine making the world better without finance. Maybe not every individual on Wall Street thinks it’s true, but the large institutions do believe you have to have power at the [ESG] table.”

If the most seasoned corners of the sustainable investing space are not yet spiking the ball or otherwise enjoying end zone celebrations, it is because they realize both how far the category has come and how much is still ahead.

For instance, Domini remains frustrated with the inconsistent and sometimes confusing nomenclature surrounding sustainable investing.

“It’s all pretty darned exciting and we enthusiastically welcome the competition, but I hate this change in vocabulary every six weeks,” she said.

To the casual observer, the vocabulary continuum of impact, sustainable, ESG, green, socially responsible, responsible investing and so on might seem like a small-potatoes issue. But it goes to the larger standardization challenge, which is surely a mountain on the near horizon for the category.

On the global level, there is optimism around efforts like the United Nations-sponsored Principles for Responsible Investing, which launched in 2010 with the support of 23 asset managers and has since gained the signatures of 90% of the world’s asset managers.

“We’ve gone from a bit unusual to ubiquitous, which means we’re now getting more information on companies and other sources,” said Andy Howard, global head of sustainability at London-based Schroders.

REGULATORS TAKING AIM

While Europe is still considered to be leading the world when it comes to ESG compliance and adoption, Howard believes the U.S. in on pace to “quickly converge with Europe” as awareness grows.

“It is becoming harder and harder for a company to just say, ‘Sustainable investing is important to us, please buy our fund,’” he said. “You have to be able to demonstrate how the fund is different, and if you’re swimming without your trunks on you should be starting to worry because more scrutiny on what this actually means is coming.”

During the first three months of the Biden administration, the Securities and Exchange Commission has announced so many climate change and ESG-related plans that it has set up a tracking website. 

Most significantly, the SEC Division of Examinations has elevated ESG as an exam priority and the commission has requested comment on its effort to expand climate and ESG disclosure requirements for public companies. 

Erika Karp, chief impact officer at Pathstone, has been focused on sustainable investing for more than two decades and embraces the most straightforward approach to the vocabulary challenges.

“The language is definitely a problem, but the only word you need to use is investing,” she said. “It’s just investing done in an in-depth and thoughtful way.”

Karp has been pushing the sustainable investing message for years and has heard most of the arguments against it.

“At that time when I started, most people perceived socially responsible investing as ideological, and not financial, but political and divisive,” she said. “But I came at it from the investment process first. Then I realized, my god, this also happens to align with my values. It’s blindingly obvious that this is the future of investing.”

Amy O’Brien, global head of responsible investing at Nuveen, the asset management arm of TIAA, also recognizes how far the sustainable investing space has come and she optimistically envisions a path to the next level.

“Just taking ESG into account is not good enough anymore, because people want real outcomes,” she said. “I see more credibility and more demand for capital flowing to where it can make a difference, and that’s where it all started.”

O’Brien, who has worked in the sustainable investing space for 25 years, recalls the evolution from a niche industry.

“Much of my career was about legitimizing and professionalizing ESG,” she said. “Five to 10 years out, I think it will become universal for all investors, regardless of motivation, and it will be necessary to incorporate material ESG factors into investing. There will be very concrete measurable outcomes. That’s where we’re heading.”

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