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Portfolio > Portfolio Construction

Another Way ESG Investing Can Boost Portfolios

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Advisors investing client assets for the long term now have another reason to invest some or all of those assets based on environmental, social and governance factors: ESG investing, by its very nature, takes a long-term approach.

“The ability to analyze and quantify the environmental and social impact at the individual portfolio level, let alone at a systemic level, requires analysis over the long timeframe,” according to a new report from Merrill Lynch Wealth Management. “This need to take a long-term view is an important distinction for impact investing.”

(Related: GMO’s Grantham: ‘We’ve Created a Toxic World’)_

The distinction stands in sharp contrast to the short-term approach that has been dominating financial markets and can erode potential long-term returns, according to the Merrill report.

It cites research, appearing in The Atlantic magazine that the average holding time for stocks fell from eight years in 1960 to eight months in 2016 and that 80% of the CFOs say they would sacrifice economic value of their firm to meet quarterly expectations. The results are high turnover in investments, which involves trading costs that can reduce gains; more share buybacks by corporations instead of investments in capital equipment or employees; and increased risks in those stocks, according to the report.

(Related: Impact Investing Takes Flight With Big Investors)

“An agricultural firm that doesn’t take into account the environmental impact of its operations is not considering the potential negative impact of climate change or the potential that consumer preferences [that] … shift to sustainably produced goods may have on it future ability to grow and sell their crops.”

A recent report from the Sustainability Accounting Standards Board (SASB), cited in the Merrill report, estimates that climate change risk affects 93% of the U.S. equity market. “By integrating ESG factors in the investment process, investors can potentially lower not only the risk they face from individual companies, but if applied broadly by the majority of investors … the market could conceivably lower the systemic risks faced by all,” according to the Merrill report.

(Related: Socially Responsible Investing Designation for Advisors to Debut This Fall)

Institutional investors have been leading the way on sustainable investing, which was a hot topic at a recent UBS CIO (Chief Investment Office) Global Forum held in New York.

“If you’re not thinking about these issues, you’re not doing a good job thinking about long-term returns,” said Andrew Lee, head of Americas sustainable and impact investing at the UBS Global Wealth Management CIO. “This is a key part to investing to achieve risk-adjusted returns.”

(Related: ESG, Sustainable and Impact Investing: An Advisor’s Guide)

Getting away from the “short-termism” of quarterly reporting would help in those efforts, said Cindy Rose, head of responsible investing at Aberdeen Standard. “That’s the bit we have to lengthen so we can actually make these changes.”

Merrill Lynch reports there is already a shift underway in the fiduciary community, primarily pension funds, to include ESG factors in order to identify investment risks and opportunities.  Failing to do so “is a failure of fiduciary duty,” according to a 2016 United Nations study cited in the Merrill report.

 (Related: ESG Investing Is Missing From Most US Retirement Plans: GAO)

Almost $23 billion was invested in ESG-related assets at the beginning of 2016, according to the latest data from the Global Sustainable Investment Alliance. About one-third of those assets were professionally managed in the U.S., accounting for roughly one-fifth of professionally managed U.S. assets, according to the U.S. Forum for Sustainable Investing (US SIF). The U.S., however, lags Europe, Australia and New Zealand, where more than 50% of investments consider ESG factors, according to the Global Sustainable Investment Alliance.


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