With improved data and research, ESG enters the investment mainstream.
Spurred by the global financial crisis and concerns about climate change, sustainable investing has experienced tremendous growth over the past decade. Assets under management have grown to an estimated $22.9 trillion globally, up from $3.8 trillion in 2006 (EXHIBIT 1). Defined as any investment approach that factors in environmental, social, and corporate governance, or ESG, issues and their impact, sustainable investing is also benefiting from other trends. Built on the already established foundation of socially responsible investing, the field today is aided by more-sophisticated ESG metrics, increased corporate focus on sustainability, supportive academic research, an organizational infrastructure, and competitive performance.
Catalysts: Financial Crisis and Climate Change
The financial crisis was an example of excessive risk-taking and short-term thinking. The crisis lowered investor confidence in the financial system and alerted investors and corporations to the risks of systemic failure. In its aftermath, investors became interested in focusing on hidden risks, corporate responsibility, systemic threats, and taking a longer-term perspective. All of these are fundamental concerns of sustainable investing.
In the wake of the financial crisis, another systemic threat began to attract investors’ attention: climate change. While evidence that human-caused global warming had been accumulating for decades, climate change burst onto the public agenda in 2006 when former Vice President Al Gore released the film An Inconvenient Truth. Since then, climate change has become a much bigger concern to investors who want to better understand the risks faced by companies, industries, and entire economies.
Earlier this year, two of the world’s largest asset managers, BlackRock
The field has become more sophisticated over the past decade at addressing key ESG issues like climate risk. Asset managers have better data on how companies address the challenges, and academic research suggests that attention to these issues can reduce risk, help identify quality companies, and enhance performance. Institutions are emerging to provide education, research, and platforms for ESG discussion, and performance of ESG portfolios is competitive with that of conventional funds and improving.
Better ESG Metrics
It is common today for asset managers to use company-level ESG metrics in their investment process, regardless of whether they are running sustainable investment funds or conventional funds. ESG data give asset managers the ability to evaluate companies on hundreds of indicators, to make comparisons relative to peer groups, sectors, and regions, and to assess a company’s progress on improving its ESG performance. That would not be possible without data collected by research firms such as Sustainalytics and MSCI ESG Research.
Still something of a cottage industry in 2006, ESG research firms covered fewer companies and measured fewer ESG indicators. A decade later, not only is the data more robust, it has accumulated into a time series, making it more useful for academic research. A recent MSCI study (Zoltan et al. 2015) suggests that “ESG momentum”—an improvement in a company’s ESG performance based on time series data— is a positive factor for performance. As the ESG research industry has consolidated, with Sustainalytics and MSCI ESG Research becoming the market leaders, at least seven other companies provide ESG research today, along with upward of 100 other organizations that focus on more specialized issue areas, according to the Global Initiative for Sustainability Ratings. For many asset managers, this research is a starting point for their own ESG analysis or an input into their evaluations of securities.