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The evidence is piling up against advisors who remain skeptical on environment, social and governance investing. A recent study by Amundi SA found that government actions and corporate scandals have forced  a “wake-up call” to scrutinize companies for ESG friendliness, something even sovereign wealth funds and central banks are acting on.

The study states, “As ESG is an issue that can no longer be overlooked, regulators are joining the conversation,” for example, the European Union is already working on a framework to “harmonize” an approach toward socially responsible investing.

Here’s the rub: In its study looking at two periods, 2010-2013, and 2014-2017, Amundi found that “between 2010-2013, being a responsible investor would have tended to penalize both active and passive European and North American portfolios.” In fact, the study found only environmental-focused passive investors in the Eurozone would have “enjoyed outperformance,” while governance and social focused portfolios would have been neutral or negative performance.

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However, things are better from 2014-2017, in that the study found “responsible investing was generally a source of outperformance in the Eurozone and North America.” Further, although all ESG areas performed well in the Eurozone, the governance “pillar” dominated. In North America, all pillars did well, with environmental being the strongest.

Other findings included that:

  • ESG-induced performance improvements must be implemented carefully: there is a tipping point beyond which ESG score improvements reduce the investment universe and hence, can negatively impact diversification and performance.
  • Responsible investing has become a beta strategy in the Eurozone, but remains an alpha strategy in North America.
  • ESG screening does not necessarily improve drawdown management.
  • To seize the benefits of ESG investing for the portfolio profile, passive investors need to accept additional, yet controlled, trading error compared with capitalization-weighted benchmarks

Real World: Nuveen

Martin Kremenstein is head of ETFs for Nuveen, which of its almost $1 trilllion in AUM, has about $20 billion in ESG across all assets. Of that, $410 million is in ESG ETFs. Eight of its ETFs are ESG funds, the first five of those launched in December 2016. Kremenstein told ThinkAdvisor that they observed from their early back testing that the only significant lag they found was in the large cap growth “and that was very much due to [us] not having high FANG exposure,” he said.

“[What we’ve seen] is that incorporating ESG with other factors can enhance performance, and mostly in value, which makes sense. Value is looking for well-priced stocks, and ESG can really be seen as another way of looking at quality…” he says.

He does believe standardization of reporting and data points for ESG “would be great. It would make our lives a lot easier,” although the Nuveen team is “able to measure those factors” effectively

He says in building products, they start, for example, with a large cap universe using MSCI large value data. Then they screen out firearms, alcohol, tobacco and nuclear power.

They also do “controversy scoring,” thus avoid firms that have a “material business risk,” such as in technology privacy and data security. That would include firms like Equifax, with its hacking problems, and Facebook, in its release of private data. He says they were aware of issues at both firms before the big “scandals” because Equifax had been hacked prior to the big one, and Facebook had to sign an “accord” with the SEC in 2014 with its privacy disclosures.

“So when a company has issues, how do they deal with it?” he says. “Did they fix it or do they just say, well, you know let’s make a calculation whether it costs us more to fix or [just payout penalties, lawsuits, etc.].

From there, they carbon score the stocks, ”which removes any company with fossil fuel reserves.” By eliminating that, “it enables us to keep mining and energy sectors, but also enables us to meaningfully reduce the carbon footprint of the end portfolio.”

Nuveen then takes each company and ESG scores them within their sectors. Within energy, environmental needs to score high, whereas within tech, privacy and social factors are key. Then they take the top 50%of each sector and build portfolios from there.

“Performance in the market is really key, and we’ve shown that in two years, three of our five [ESG] products are in the top quartile,” Kremenstein said. He adds that “even if an advisor does not believe in the social side, or values side of ESG, they should be able to appreciate that when you look at value investing — not values, but value investing — adding value ESG offers meaningful alpha.”

He also understands why advisors may be reticent to jump in. “They’re absolutely right to be skeptical,” he says. “We have a long history of ESG and responsible investing,” he says of Nuveen. “But there are a lot of asset managers that are suddenly jumping into the fray, which is crowding the space, and [causing] skepticism.”

That said, he says “we believe ESG is a long-term movement. It’s already made huge ground in the institutional space, and it takes time to percolate to the retail space. We’re seeing the amount of inquiries from advisors and investors now that far outweighs anything we’ve gotten [in the past.]”

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