Morgan Stanley’s Chad Graves III tells a story about sitting in many a meeting with ultra-high-net-worth families, where the patriarch was sitting on one end of the table and the family’s millennials were sitting on the other. “By the end of the meeting we’d have a chunk of assets in sustainable investments we never would have had if the next generation hadn’t been there,” he told an audience at the 2015 Morningstar Investment Conference. “So when we talk about wealth transfer that is coming in 30 years, the fact of the matter is, it’s happening today. There is a huge opportunity out there.”
Environmental, Social and Governance (ESG) investing has exploded in assets under management since 1995, when there was $639 billion tagged to it, while today that amount is $6.2 trillion, according to Jon Hale, director of manager research, North America, for Morningstar, who moderated a panel of ESG experts at the conference on June . This explosion mirrors client appetite.
According to an February 2015 Morgan Stanley survey of 800 investors, 71% were interested in ESG investing; which includes 84% of millennials, 76% of women, and 62% of men. Further, the number of signatories on the United Nations Principles for Responsible Investing declaration has grown dramatically. In 2006 there were only nine signers of that document, whereas today there are 1,380 asset owners, investment managers and service providers with $59 trillion in AUM on board.
What doesn’t coincide with this growth is advisor interest in ESG investing: According to data cited by Graves in his presentation, only 7% are highly interested, 30% somewhat interested, and a whopping 63% had little or no interest. As Graves quipped: “If that slide doesn’t scream opportunity, I don’t know what does.”
Impact and Returns
Joe Keefe, CEO of Pax World Management, explained that when his fund was launched in 1971, most of these types of funds had the antecedent of religious-based investing, basically screening out anything at odds with values of faith, like Quakers eliminating weapon manufacturers or Muslins eliminating bank stocks.
“[ESG] was greeted skeptically by traditional financial circles because the notion you could shrink the investment universe for non-financial reasons and still get market returns was felt to be counterintuitive,” he explained. “That said, most studies [showed] there was no under performance back in those days, but nonetheless, it created a challenge for the [ESG] industry.”
As time went on, it was found ESG factors actually had financial materiality, Keefe said. “Studies showed firms with better employee relationships had higher productivity, higher morale, lower turnover and lower absenteeism. Firms with better corporate governance had few scandals and blow-ups. Companies with better environment practices had better cost of capital and efficiencies,” he said. “So there was increasing evidence that ESG factors could be material from a financial perspective and help you manage risk and add value on the alpha side.”
What has changed slightly is that at first clients wanted to invest in sustainable companies because “they wanted us to apply those principles,” but also said if performance isn’t as good, that was okay, noted Mary Jane McQuillen, managing director and portfolio manager at Clearbridge and head of its ESG program.
“While clients said, ‘We don’t mind if performance isn’t so good,’ we couldn’t ignore the performance aspect,” she said. “But today is a different market lace…they have expectations of robustness” and want to understand the impact their money is making to better the world as well as they want good returns.”
All the panelists were perplexed by advisor reticence to embrace ESG investing.
Graves said Morgan Stanley has done studies across the board, all showing that ESG funds skewed positive performance-wise to the overall fund universe. Keefe agreed, stating “conventional wisdom dies hard.” Hale noted one issue might be “lack of good information” on socially conscious funds.
McQuillen, whose firm does its research in house, said that the bottom line is that “ESG investing is the future,” and added, “Our CEO has said many times: why would we not? All else being equal, we have the ability to invest in quality companies, companies that are thinking long term, that are looking for [ESG] opportunities. Why wouldn’t we want to invest that way?”