Part 1: What’s Behind the Growth in Sustainable and Responsible Investing?

Kathryn L. Hersey, CFA
Aimee B. Forsythe, CFA

July 24, 2018

Investing & Economy

A growing number of individuals and institutions recognize the influence businesses can have in addressing the environmental, social, and economic challenges we face today.  By investing in high quality, sustainable and responsible companies, these investors can support integrated solutions to these challenges.


What Is a Sustainable Company?

A United Nations report in 1987 defined a sustainable business as any organization that “meets the needs of the present world without compromising the ability of future generations to meet their own needs.”[1] 

A sustainable business is one that strives to meet the triple bottom line of people, planet, and profit. 

Today, sustainability plays a vital role in sound corporate strategy. Enterprises that engage customers, employees, community members, and investors on issues that matter the most to them foster loyalty, commitment, and productivity. They view sustainability as a long-term commitment, with current actions having far-reaching implications for future generations.

As a result, sustainability has increasingly become not just a solution for the morally conscientious, but also for the financially responsible.  A company that proactively addresses issues today can protect itself from future problems and lay the groundwork for long-term success for the firm and its stakeholders.

From a portfolio management perspective, companies with strong sustainability attributes perform well in comparison to their peers.  The oldest index of sustainable investments, the MSCI KLD 400, has outperformed the S&P 500 since it was first introduced in 1990.



Chart 1

Source: Bloomberg; MSCI KLD 400 Social Index is a cap weighted index of 400 US Securities that provides exposure to companies with outstanding Environmental, Social and Governance (ESG) ratings and excludes companies whose products have negative social or environmental impacts. – Source: MSCI

 

[1] United Nations General Assembly (1987) Report of the World Commission on Environment and Development: Our Common Future.


Evolution of the SRI Discipline

Recognizing the desire of their clients to invest in a more sustainable future for the next generation while investing toward their financial goals, investment firms have increasingly adopted an investment discipline known today as Sustainable and Responsible Investing (SRI).[1] At Cambridge Trust, we view SRI as an investment discipline that considers environmental, social, and corporate governance (ESG) criteria to generate long‐term competitive financial returns and positive contributions to society.
 
Investment managers typically consider a number of ESG criteria when evaluating and selecting companies based on their sustainability. Examples of these criteria are shown in the diagram below:


Chart 2
 
As interest in investing using ESG criteria has grown over the past two decades, SRI has evolved from a niche interest to a key consideration for portfolio management. For example:

  • Early adoption of SRI practices was driven by investors whos religious beliefs compelled them to avoid investing in enterprises that profited by enslaving or harming other human beings.
  • ​The modern roots of SRI lie in the tumultuous political climate of the 1960s and 1970s, when sensitivity to issues of social responsibility and accountability emerged in response to the Vietnam War, the Civil Rights movement, and Women’s Equal Rights campaigns.
  • In the 1970s and 1980s, individuals, churches, universities, cities, and states focused their investment strategies on pressuring the white minority government of South Africa to abolish the apartheid system and divest from companies involved with the regime.

​In the following decades, environmental concerns, labor practices, and weak corporate governance practices have been challenged by investors.  Climate change, the use of renewable energy, and “fracking” practices in the energy industry have been of particular focus.


[1] https://www.ussif.org/sribasics

Today, ESG factors have become important metrics for use in constructing Sustainable and Responsible Investment portfolios. [LINK to Part II] Portfolio managers and investment analysts scrutinize issues such as CO2 reduction, corporate community impact, and executive pay alongside more traditional investment research criteria to understand the full impact of the company and determine its long-term outlook. As individual investors increasingly see the influential role that businesses play in preserving our planet, they also seek to invest in companies exhibiting positive sustainability characteristics.


A Strategy with More Growth Potential

SRI is growing at a rapid pace as shown in Chart 2. According to The Forum for Sustainable and Responsible Investing (US SIF): [1]

  • The size of the SRI market increased nearly 14-fold from 1995 (when they first started measuring it) to 2016, with a compound annual growth rate of 13.25%.
  • By the start of 2016, assets managed in accordance to an SRI strategy represented 22% of the $40.3 trillion in total U.S. assets under management tracked by Cerulli Associates.
  • Institutional asset managers across the United States who now consider ESG criteria in their investment analysis and portfolio selection oversee aggregate assets of $4.7 trillion, a 17% increase since the start of 2014.



Chart 3

Source: US SIF Foundation

[1] US SIF Foundation, The Forum for Sustainable and Responsible Investment, 2016 Report on Sustainable and Responsible Investing Trends,
Executive Summary.

In terms of the investments themselves, according to the US SIF Foundation, there were 1,002 investment funds that incorporated ESG factors in 2016, more than double the number in 2010 (Chart 3). They included exchange-traded funds that mirrored a broad index, such as the iShares MSCI KLD 400 Social Index, and funds that targeted a specific sector of the market, such as the PowerShares Global Water Portfolio.

 

Chart 4

Note: Number of funds include mutual funds, variable annuity funds, closed-end funds, exchange-traded funds, alternative investment funds and other pooled products, but exclude separate accounts, Other/Not Listed, and community investing institutions. From 1995-2012, separate account assets were included in this data series, but have been excluded since 2014.

This significant growth has been fueled by:

  • A desire to consider social and environmental impact within investment portfolios
  • Academic evidence and performance results that show ESG-based portfolios perform as well as their benchmarks
  • Investor education and awareness
  • Ongoing efforts to increase the transparency and consistency of information on SRI [LINK to Part II] by the US SIF, SASB, Global Reporting Initiative (GRI), and the United Nation’s Principles for Responsible Investment (PRI)[1]
  • The availability of SRI options offered by asset and portfolio managers 

As SRI continues to become more understood, investors will be able to make more informed and effective decisions about investing in a meaningful, sustainable and responsible manner.
 
This article is for informational purposes only and should not be construed as investment or legal advice. 


[1] Principles for Responsible Investment, http:///www.unpri.org