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What’s driving the rise of ESG investing?
Jade Huang, Portfolio Manager, Calvert Research and Management
Bethesda, MD - Environmental, social and governance (ESG) investing is one of the leading trends in asset management. In 2016, more than $8.5 trillion was invested with consideration of responsible investment criteria in the U.S. alone — a 33% increase since 2014, according to The Forum for Sustainable and Responsible Investment.
There are several factors driving this growth. First, more individual investors are simply interested in building portfolios that line up with their values. They are finding they don't have to sacrifice performance to do so.
In fact, as sustainability issues like climate change and human rights increasingly impact sectors across the economy, investors are discovering that the consideration of ESG in company analysis can be alpha-generating signals that may help long-term investment performance.(1)
Also, large institutional investors are increasingly using ESG in their investment process as a way to identify high-quality companies with strong management teams. Often, management teams of companies with strong proactive sustainability profiles also have a track record of being able to better manage risk, adapt to changes, and take advantage of opportunities over the long term.
Another emerging theme in ESG investing that we believe drives growth is the concept of "materiality." This is the degree to which ESG factors impact the company's bottom line and stock price, or significantly impact society or the environment. In this approach, consideration of ESG issues is focused only on issues that are most impactful on financial performance, a security's price, or society and the planet.
For example, climate change tends to be more material to property and casualty insurance companies, so understanding how that is being considered in the underwriting process is important. Conversely, a software company's management of water would be immaterial compared to a beverage company, for example. The idea is to focus on issues that impact financial performance, rather than basing decisions on ESG issues that have little relevance to the long-term performance of the company.
Bottom line: We believe ESG investing is a strategy that can deliver strong performance over the long term given its role in understanding how well a company is managing its capital, including its financial, natural and human capital.
(1)Alpha measures risk-adjusted performance, showing excess return delivered at the same risk level as the benchmark.