5 Big Things About Sustainable Investing in 2017

The Trump Effect After years of increasing momentum for sustainable investing, 2017 began with concerns that the new administration would have a chilling effect on the field's growth.

The concerns had to do with President Donald Trump promising to "bring back coal," roll back Barack Obama's Clean Power Plan, and pull the United States out of the Paris Climate Agreement, all of which, it was feared, could hurt investments in renewable energy and, more broadly, in companies better aligned with the transition to a low-carbon economy.

Another concern was that corporate America would fall into line with Trump's vision to "Make America Great Again" by dropping all pretense that it cared about sustainability issues. Given these concerns, the thinking went, investors might abandon sustainability and move on to other themes.

But that didn't happen. If there was a "Trump effect" at all, it was as a galvanizing force for sustainable investing. Sustainability may resemble an investment theme, but it's broader than that. It's an approach to decision-making, which in the investment context means a long-term focus that's inclusive of stakeholders, that recognizes that the transition to a low-carbon economy will produce winners and losers, and that investors can have an impact on creating a low-carbon global economy that works for more people.

The number of investors adopting that approach continued to grow in 2017. According to a recent Callan report, more foundations in the U.S., especially large ones, and public pension funds began incorporating ESG into their investment processes this year. A Brown Brothers Harriman/ETF.com survey of "sophisticated ETF investors in the U.S." found a dramatic increase in interest in environmental, social, and governance exchange-traded funds this year (51%) versus last year (37%). Retail funds posted a record year of flows, with more than $5.0 billion in net flows through November, compared with an estimated $4.8 billion for all of last year. Twenty-seven new funds and ETFs were launched. And surveys continue to report high levels of interest in sustainable investing among women and millennials, but also among baby boomers.

As for companies, I saw little evidence of firms abandoning sustainability in 2017. Why would they? A well-managed company understands the need to assess material ESG risks and opportunities facing its business and to incorporate them into its long-term strategy. That understanding is underscored by a redefinition of corporate responsibility, driven by younger employees and women, who are gradually moving into decision-making roles. Which brings me to the second thing about sustainable investing in 2017:

The Fearless Girl State Street Global Advisors (SSGA) had the marketing coup of the year with its Fearless Girl statue, commissioned on the first anniversary of the launch of the SPDR SSGA Gender Diversity Index ETF SHE and placed opposite the Wall Street bull in time for International Women's Day in early March. The statue was such a hit that it has been permitted to remain in place until March 2018--and I suspect it will be there longer than that.

The Fearless Girl served notice that investors are not going to drop the pursuit of gender equality. Just 5% of S&P 500 companies are headed by a female CEO, 20% of board seats are held by women, and 25% of executive and senior level managers are women. (The investment industry doesn't do any better. A Morningstar report this year found that roughly 20% of funds globally have at least one female manager.)

Shareholders focused considerable attention on this issue in their engagements with corporate management this year, submitting 35 diversity resolutions. Only eight came to a vote, while the remainder were withdrawn, an indication that those companies were willing to address the issue in a way that was suitable to concerned shareholders. For the first time,

The Big Three Ramp Up Their Engagement Activity As their passive assets under management have grown and they have become the largest shareholders of most large companies, the Big Three of passive investing--BlackRock, SSGA, and Vanguard--have become more rather than less engaged in stewardship activities, according to a Morningstar report released earlier this month.

That may be surprising to some. Passive investors are, in effect, universal owners. They own every company in a market and will own those companies in perpetuity, so, it is said, they should have little incentive to bother with the costs associated with engagement. Despite being the largest shareholders of most companies, passive investors have little leverage with a company to change its behavior because they cannot divest.

So why are the largest passive asset managers getting more involved in stewardship activities?

For one thing, they still have a fiduciary duty to their shareholders. Even without the possibility of exiting a position, being among a company's largest shareholders gives the passive asset manager a voice in the way a company is run, advocating for company policies and behavior that can enhance shareholder value. For a large, passive asset manager to ignore that influence would be to shirk its fiduciary duty to its own investors.

Secondly, large passive asset managers have a public responsibility to be active owners. A large passive asset manager that decides to be a passive owner is saying it doesn't care how a company is run and therefore shares in the responsibility for bad corporate behavior. When major instances of corporate mismanagement occur, better to be on record as a shareholder that engaged with the company on the issue than to be a passive owner that by virtue of sitting on the sidelines has further empowered management and weakened the position of other shareholders. This connection is starting to be made more often in media coverage and can result in a reputational hit to asset managers that are passive owners and, conversely, a reputational plus for those that are active owners.

Third, large passive asset managers have a responsibility to exercise systemic stewardship. With their perspective as the largest shareholders of most large companies and as permanent shareholders, they can focus on long-term issues that can help preserve and improve the financial system itself, which would, in turn, enhance long-term shareholder value. That's why they focus on ESG issues like gender diversity in corporate leadership and climate-risk disclosure, which are really about long-term corporate and systemic sustainability. The large passive asset managers can help bring long-term considerations that have traditionally sat just beyond the purview of shareholders and corporate strategists into the present discussion between management and shareholders.

Climate-Risk Disclosure

This is number four on the list, but perhaps the most consequential of all. Led by the aforementioned Big Three, efforts to get companies to disclose the risks they face from climate change gathered force in 2017. It started off with almost unheard-of majority shareholder votes on climate-risk disclosure resolutions at

, on the second anniversary of the signing of the Paris Agreement, a group of global investors launched an initiative called

to drive action on climate change among 100 companies that are the world's largest greenhouse gas emitters. Also last week, Exxon announced in an

that it would follow the recommendation of its shareholders and release information on "energy demand sensitivities, implications of two degree Celsius scenarios, and positioning for a lower-carbon future."

Assuming investors are successful in spurring more companies to take action on climate disclosure, as they've now been with Exxon, their efforts could have a major impact not only for all investors but for companies themselves by enhancing understanding of climate risks. And by spurring companies to better understand their climate risks, these efforts can lead to more firms taking action to reduce their carbon footprints, thereby achieving the broader impact of reducing greenhouse gas emissions in line with the Paris Agreement.

Impact That brings me to "impact," the fifth big thing of the year for sustainable investing. Impact is a key outcome of sustainable investing, but more attention has been paid in recent years to incorporating ESG analytics in the investment process as a way to enhance financial returns. Impact became a bigger focus this year.

That's a good thing, because if you are interested in sustainable investing, chances are you would like your investments to have environmental and societal impacts alongside competitive financial returns. Indeed, the very idea of sustainable investing is the win-win proposition that it can deliver on both fronts. And that's what resonates with most sustainable investors. In a recent global investor survey of more than 22,000 investors, for example, Schroders found that sustainable investors see positive impact and financial returns going "hand in hand." Two thirds of Americans in the survey said they are interested in sustainable investing mainly for its impact or for both its impact and its financial return. Only one third said they were interested in it for financial return only.

It's important to note that the widespread and still-growing use of ESG analytics in investment decision-making is itself impactful. It signals that sustainability issues are important and encourages companies to take them seriously. When companies take sustainability issues seriously, they believe it will help their business and, in so doing, they will have a broader environmental or societal impact. Those who are invested in public equity strategies that incorporate ESG are having an impact even if their asset managers are using ESG strictly to improve financial performance.

More broadly, the UN Sustainable Development Goals have been widely discussed--and adopted--this year as a framework for assessing impact. Asset managers are doing this by targeting certain goals or by simply identifying which of the 17 goals are supported by investments in their portfolios, and then developing metrics to assess the impact they're having. More asset managers are rightfully emphasizing their stewardship activities as one of the key ways they are delivering impact, and they are figuring out how to improve their reporting on impact to their investors.

Sustainable investing heads into 2018 with continued momentum, focused on delivering impact alongside financial returns.

Jon Hale has been researching the fund industry since 1995. He is Morningstar’s director of ESG research for the Americas and a member of Morningstar's investment research department. While Morningstar typically agrees with the views Jon expresses on ESG matters, they represent his own views.