Sustainable investing: Beyond the tipping point

Sustainable investing has now reached a tipping point. 

Morgan Stanley’s bi-annual Sustainable Signals survey, published in May, interviewed 110 asset owners from North America, Europe and the Asia-Pacific region and found that the majority recognize that considering environmental, social and governance policies will be standard business practice.

Some, 57% said they foresee a time when they will only allocate to third-party investment managers with a formal ESG policy. 

That’s encouraging news, although not much had changed since Morgan Stanley’s previous report in 2018. The asset owners again listed risk management and return potential as the main drivers for adopting sustainable investment policies. 

Indeed, if there were still doubts that firms with good ESG perform better and have less downside risk those have surely been ironed out over the Covid-19 crisis.

By the time you file this article there will be more ESG ratings providers than when you started 

 – Audrey Choi, Morgan Stanley

In May, S&P Global Market Intelligence released its analysis of 17 exchange-traded and mutual funds with more than $250 million in assets under management that select stocks for investment based in part on ESG criteria. 

Of those funds, the report showed that 14 have lost less value this year than the S&P500, up from 12 in April. 

The top performer in the latest analysis, the Nuveen Winslow Large-Cap Growth ESG Fund, even gained 3.4% in the year to May 15, compared with an 11.4% decline in the S&P500. 

One difference, however, in the more recent Morgan Stanley data is the role of stakeholder appetite. 

The single most important driver listed by asset owners for investing sustainably this year was ‘constituent demand’, indicating that an ESG strategy is now simply part and parcel of fiduciary duty: end investors, pension fund trustees and shareholders are all pushing for change. 

Some 68% of asset owners surveyed said they agreed it was part of a fund’s fiduciary duty to integrate sustainable investing practices. 

Better policies

These are all positive signs that should help build better policies. If airlines, for example, are not encouraged to be more environmentally sound, they run the risk of being shut out by investors at a time when they need capital most. 

The top four themes listed by asset owners were, in order of importance, climate change, water solutions, plastic-waste reduction and a circular economy. 

Audrey Choi, Morgan Stanley’s chief sustainability officer

The survey, however, was carried out before the Covid-19 crisis, and so today it is likely that themes such as ‘health and nutrition’ and ‘community development’ might score higher, according to Audrey Choi, Morgan Stanley’s chief sustainability officer. 

Data from Truvalue Labs, for example, shows that social categories within Sustainability Accounting Standards Board (SASB) guidelines have been receiving more public attention than environmental categories since the beginning of February this year. 

While the drive to invest sustainably is clearly there, and a tipping point seems to be have been reached, there are still some big obstacles to be overcome. 

Almost a third of Morgan Stanley’s survey respondents said they did not have adequate tools to assess ESG alignment, and 29% said that quality ESG data is the biggest challenge when it comes to investing sustainably – a higher number than two years ago. The data, it seems, is just becoming more confusing. 

Too many ratings

Speaking to Euromoney for its recent podcast on ESG ratings, Peter Bakker, president and chief executive of the World Business Council for Sustainable Development, referred to the 600 ESG rankings and ratings from over 100 ratings companies, and more than 4,000 key performance indicators as “a bit of a zoo”.

He is right. It’s become a competitive business, with agencies charging corporates up to $300,000 for a rating that may agree or disagree with the next paid-for rating the firm gets. The whole sector is now crowded, and most likely not very accurate.

“By the time you file this article there will be more ESG ratings providers than when you started,” Choi tells me – only partly joking. 

That means many asset managers have to come up with their own metrics, adding yet more key performance indicators – and noise at the zoo – and leaving end investors even more confused. 

Most asset managers don’t disclose how they determine their own scoring systems. 

Standardization

This long-standing issue of data discrepancy and lack of standardization may now finally be addressed. 

SEC chairman Jay Clayton, who is no stranger to questioning the quality of ESG data, has again cautioned that combining E, S and G actions into a score may not result in anything useful for investors. 

The SEC is asking asset managers for feedback on the topic, while there are also recommendations from an SEC subcommittee that the SEC establish ESG disclosure requirements.

The subcommittee making the recommendations has stressed that the US should be leading the charge to build the framework for the data required for investors. 

Meanwhile, the European Commission is reviewing its Non-Financial Reporting Directive, which covers how large companies disclose how they operate and manage social and environmental issues. The public comment period ends on June 11. 

Such efforts may not bode well for the 100-odd ESG ratings providers, but they will be good news for people and the planet.