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Portfolio > Portfolio Construction > ESG

Despite SEC Scrutiny, ESG Investing Growth to Continue in 2020

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The August declaration by the Business Roundtable, a group that includes many of the largest corporations in the United States, in stating that companies need to be more responsible to all stakeholders — rather than just shareholders — was a turning point in the move toward socially responsible investing. Institutions publicly declared the need to follow these principles to make them better stewards.

Indeed, environmental, social and governance focused ETFs and open-end funds (also including sustainable and impact investments) received $17.7 billion in net flows in 2019 through November, according to Morningstar Direct. That’s triple the total in 2018, according to Jon Hale, Morningstar’s head of sustainability research.

And performance is keeping up and surpassing regular returns. Writes Hale in his blog, “Among large-cap blend funds, the returns of nearly half (48%) of sustainable funds are ahead of the S&P 500 for the year to date, compared with only 22% of large-blend funds overall.”

The consensus is these types of funds will grow — already there are an estimated 500 — but the Securities and Exchange Commission has sounded an alarm. Not only did Commissioner Hester Peirce rise up against proxy voting firms, which the commission is now debating while awaiting public comment, it recently sent an unknown number of letters to so-called impact funds, according to The Wall Street Journal, asking for details about the strategies managers are using.

Double-checking if companies really are fulfilling their stated purpose may be standard procedure for the SEC when dealing with a new sectors or products, but the proxy voting issue has become a hot point and no doubt will come to a head next year.

Says Hale, “Over the years, shareholder resolutions have helped put ESG issues front and center on many companies’ radar, helping them attend to issues before they suffer the financial consequences of ignoring them.” However, he adds, the SEC is now trying to limit these activities. In fact, the SEC voted 3-2 to “raise the thresholds for shareholders to propose resolutions at annual company meetings and to increase the thresholds for resubmitting such resolutions in subsequent years.”

Further, the regulator is taking aim at the influence of proxy advisors. Amy O’Brien, Nuveen’s global head of responsible investing, told ThinkAdvisor that her company uses these firms’ objective research on issues as well as the execution of voting. She adds that Nuveen owns stock in 14,000 companies through its funds, thus expedition is needed.

“It’s really the [recommendation services] that will have the most focus on for the coming year and the rulemaking process,” she said. But that all comes with a maturing market. “[We think] that there will be continued growth with all things under the broader responsible investing tent. But with growth comes more scrutiny,” she acknowledges.

Alphabet Soup

Yet O’Brien sees greater clarity and certainty for an industry that has an issue with its word taxonomy. ESG, SI and impact investing are all variations on the same theme, but there are differences, which organizations such as the [International Organization for Standardization] is working on defining.

“People are recognizing that a lack of having a dictionary is holding us back,” she says. “But there’s also a difference in the actual terms that have something to do with what’s the underlying activity versus terms that are what’s the motivation.”

O’Brien adds that in her conversations with advisors, “the overriding comment I hear is, can you all please start talking the same way?” That said, “streamlining the terminology doesn’t appear to be the issue.”

Education for both advisors and clients need to be more prevalent in 2020, says Sonya Dreizler, a consultant who works with clients interested in ESG products. She sees both more demand and more product. “Demand is across the board,” she says.

In fact, a recent study by Morgan Stanley found that 85% of investors overall were interested in sustainable investing (which rose to 95% for millennials). As Hale noted, “Perhaps more tellingly, a greater proportion [49%] in 2019 said they were ‘very’ interested in sustainable investing. In 2015, only 19% said they were ‘very’ interested.”

Dreizler also points out it is advisors who need to take the lead. “There’s a big opportunity here,” she says. Advisors would be smart to learn to educate clients on the topic — just like they would other investing strategies, she said.

“I wouldn’t expect clients to come in and ask for a 10% allocation in emerging markets,” she told ThinkAdvisor. “Clients don’t know about [ESG] and it’s not their job to keep up to date on it. Mostly they seek out experts for the financial aspects of their life, so it is up to the advisors … [who] could lose business if they [aren’t] in front of this issue.”

O’Brien also sees more employee and consumer activism, noting that corporations are paying more attention to this, not only due to social media pressure, but to attract and maintain talent. “These aspects of responsible investing really do matter to employees and consumers,” she said. “You can see how quickly people can get organized now and how consumers can push out things [on social media] that really do influence a company’s decisions.”

She also believes that “ESG in particular is going to further spread its wings in fixed income,” adding that it’s a particularly important for investors who “want that total portfolio solution.”

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