1. Investors can do good and do well. Investing in stocks that rank high on ESG metrics would have outperformed the market by up to three percentage points over the last five years, according to Bank of America Merrill Lynch.
2. A tsunami of assets is poised to invest in “good” stocks. Merrill estimates ESG fund assets will grow over $20 trillion over the next two decades based on demographics. Three investor cohorts care deeply about ESG: women, millennials and high-net-worth individuals.
3. Seventy percent of U.S. assets can’t be analyzed without using ESG criteria. Those metrics are particularly helpful in measuring intangible assets such as those tied to reputation, brand value and intellectual property, which have reached record highs for S&P 500 companies. ESG criteria can measure corporate management decisions that affect operational efficiency and future strategic directions. “Analyzing financial metrics alone simply won't suffice anymore.”
4. Happy employees = better returns. Companies with high employee satisfaction ratings on glassdoor.com have outperformed companies with low ratings by nearly five percentage points per year over the past six years, according to Bank of America Merrill Lynch.
5. ESG ratings are the best signal of earnings risk. Traditional financial metrics such as earnings quality, leverage and profitability don’t come close to ESG as a signal of future earnings risk or earnings-per-share volatility.
6. ESG could have helped avoid 90% of bankruptcies. Fifteen of 17 bankruptcies in the S&P 500 between 2005 and 2015 were of companies with poor ESG scores five years before their bankruptcies.
7. “Good” companies enjoy a lower cost of capital. Companies with higher ESG scores can pay as much as two percentage points less in interest on their debt.
8. ESG “controversies” cost investors. Major ESG-related controversies during the past six years resulted in $534 billion worth of losses in market cap for large U.S. companies, when measured from peak to trough.
9. Climate change is top of mind for investors. It’s the top ESG issue for ESG-focused asset managers, according to the U.S. Forum for Sustainable and Responsible Investment (US SIF). Roughly $3 trillion of ESG assets consider climate change as part of their investment decisions.
10. Actually you already do care about ESG. Stocks have been bought and sold based on ESG concerns for decades, but that concern now is shared among a greater number of investors, asset managers and corporations. Today’s ESG discussions are largely focused on standardizing these elements. An increasing number of stock exchanges mandating ESG disclosure in their listing requirements is one reflection of that growing demand.
Assets in sustainable, responsible and impact investment assets reached almost $31 trillion by the start of 2018, up 34% from 2016, and they grew at even faster rate in the U.S., according to the Global Sustainable Investment Alliance (GSIA).
Sustainable investments in the U.S., including assets chosen based on their environmental, social and governance ratings, increased at an even faster rate, rising 38% to $12 trillion and accounting for 26% of all professionally managed assets.
In the past year, many asset managers including Vanguard, Fidelity, BlackRock and Nuveen have introduced sustainable and/or mutual funds or ETFs that choose investments based on their ratings for ESG criteria. In addition, about 200 funds not previously focused on ESG ratings have added ESG considerations to their investment process. BNP Paribas has taken an even more favorable stance toward sustainability, adopting an ESG overlay for all its investment strategies.
Also, MSCI Inc., which develops investment indexes that are used as the basis for passive funds and the benchmarks against which actively managed funds are measured, has added ESG ratings for 32,000 equity and fixed income mutual funds and ETFs, scoring each for their long-term ESG risks and opportunities.
Year to date, sustainable funds attracted an estimated $8.9 billion in net flows during the first half of this year – well more than the $5.5 billion they attracted for all of last year, according to Jon Hale, head of sustainability research for Morningstar.
Despite the growing popularity of ESG-rated and sustainable funds, many financial advisors hesitate to invest client money in sustainable assets. Their reasons vary but often include the lack of standardized measurements to measure ESG criteria and concerns about performance. But there is an increasing amount of data showing that companies that score high on ESG ratings and funds that more heavily weight those assets match or outperform their non-ESG counterparts, in part because of higher risk-adjusted returns. Morningstar, for example, found that among the more than 250 sustainable funds it rates, about 60% finished in the top half in 2018 and during the first half of this year.
Given the growing popularity of ESG funds, Bank of America Merrill Lynch has updated its ESG primer, providing 10 reasons why investors should care about ESG. The reasons could also be helpful to advisors, especially those whose clients are asking for ESG-focused, socially responsible or impact investments, or are potentially interested in such investments. Check out the slideshow above to learn more.
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