Sustainable Investing in the 21st Century

This analyst blog is part of our coverage of the 2015 Morningstar Investment Conference.

The field of socially responsible investing, now often known as sustainable investing or ESG (environmental, social, and governance) investing, has grown and evolved quite a bit during the past decade. By one estimate, more than $6 trillion is now invested in ESG portfolios, about 3 times the figure from 10 years ago.

Rather than just screening out stocks involved with alcohol, tobacco, gambling, and other "bad" things, today's ESG investors tend to take a more holistic approach; they seek out investments with the most positive features, often those actively working to make the world better in various ways. The participants in the "ESG Investing" panel at the 2015 Morningstar Investment Conference--Chad Graves of Morgan Stanley Investment Management, Joe Keefe of Pax World, and Mary Jane McQuillen of ClearBridge--provided plenty of insights into this evolution and the current landscape of ESG investing.

Keefe, as CEO of one of the major sustainable fund shops, admitted that the shifts in terminology may have been confusing to some people but noted that they represent real changes in the way people have approached this type of investing. Traditional socially responsible investing grew out of religious investors who wanted to eliminate "sin stocks" of various kinds from their portfolios, but it evolved into ESG investing when people recognized that a broader range of environmental, social, and governance factors could have a material impact on company results. For example, companies that treat their employees well tend to have lower turnover, and firms with good governance practices are less likely to suffer scandals or blowups.

This has further evolved into "impact investing" as people have sought to own companies that are actively working to make the world a better place. Graves confirmed that his wealth-management clients at Morgan Stanley want their investments to have an impact in the real world, above and beyond the financial results. One example he mentioned is "green bonds," which finance clean energy and other environmentally friendly projects.

The panelists went on to discuss how they incorporate this new form of ESG into their investment process. McQuillen, who has spent many years managing ESG portfolios for ClearBridge, explained that she considers ESG factors at the idea-generation level, and that ClearBridge's analysts research such factors alongside more-traditional financial metrics. Keefe noted that Pax World similarly does all its ESG research in-house, grading all the companies within an industry and trying to own the best ones. It's now possible to hire third-party firms to do ESG research at a company level, but for McQuillen and Keefe, at least, ESG criteria are intertwined with the rest of their investment process.

On a related note, Graves explained that the increased demand for ESG investment products in recent years has led to a lot of people "jumping on the bandwagon in a superficial way." When seeking out ESG portfolio managers for his clients, he looks for "authenticity," meaning investors who integrate ESG factors into their entire process like McQuillen and Keefe do, rather than just screening out a few stocks. "It's important to understand the depth of their knowledge before we put them before our clients," he said. "At its core, we're still looking for good investors, with good solid investment discipline, using ESG to add value."

One perennial topic that the panel addressed is whether ESG screens hurt investment performance; whether it's possible to "do well while doing good." Moderator Jon Hale noted that several studies by Morningstar have found that socially conscious funds have not performed significantly better or worse than the broader market over time, and all three panelists agreed. Graves said that Morgan Stanley has looked at the issue in three different ways--in a meta-study of academic studies, and in studies of ESG versus non-ESG funds and ESG versus non-ESG indexes--and in all three cases found no significant difference in performance. Keefe said that Pax World's own meta-study had come to similar results, while also finding a correlation between ESG and "quality" criteria, as well as a long-term perspective that tends to be good for investors.

Finally, moderator Hale noted that although investor interest in ESG investing has been growing steadily, this has been less true for financial advisors, at least so far. Graves discussed the huge opportunities in the ESG space, and said, "At a bare minimum, advisors need to be able to speak the language, and talk about ESG with your clients." McQuillen mentioned a ClearBridge survey that found that many advisors don't mention ESG because their clients don't ask them about it, among other reasons, but argued that this is shortsighted.

Keefe closed by saying that ESG investing addresses some of the most important issues facing the global economy over the next 20 years, especially climate change and gender inequality. He said that not letting women participate fully in the economy is like having one hand tied behind your back, and that "unleashing the economic power of women will unleash the greatest economic growth in the history of the planet."