Does sustainable investing need “quality control”?
By: Jon Hale
Tags: Wealth Management, Impact Investing, Sustainability, Climate Change, Investing

End of Week Notes

US SIF CEO Lisa Woll interviews Minneapolis Mayor Jacob Frey at the 2019 US SIF Conference in Minneapolis

With so many asset managers adding ESG criteria to their investment processes, does sustainable investing need “quality control”? I discussed that question with Justin Conway of Calvert Impact Capital, Michael Lent of Veris Wealth Partners, Meg Voorhes of US SIF, and a roomful of US SIF members this week at the US SIF Annual Conference in Minneapolis.

At Morningstar, our data team scours fund offering documents worldwide (prospectuses in the U.S.) for any language related to sustainable, responsible, ESG, or impact investing. Every month, it seems, the list grows, partly because new ESG or impact focused funds are being launched or, in some cases, being refashioned from existing funds. But in addition, a lot of established funds are adding a line or two in their prospectus saying they now consider ESG in security selection.

What should we make of these funds? On the one hand, I think it is encouraging to see so many mainstream asset managers adding ESG to their process. While they may be doing it for marketing purposes, it’s highly unlikely that their legal and compliance departments would allow any reference to ESG in a fund prospectus unless the investment team could actually demonstrate that it is incorporating ESG in the investment process.

On the other hand, how funds consider ESG factors is often vague and limited to security selection. Such funds should not be confused with those using a more comprehensive approach in which ESG analysis and, in many cases, impact analysis is a fundamental part of their investment process from security selection to portfolio construction to active engagement with companies they own.

If I were an intermediary — an advisor or someone who oversees a fund platform or DC plan — I might require ESG consideration to be a minimum standard for any fund that I recommend, pending clarification from managers on how exactly ESG criteria are applied. Why? Because in the world today, ESG issues affect nearly every company across the entire market and prudent asset management requires their careful consideration.

But for end investors who are interested in sustainable investing, and we know that large numbers of them are, the focus should be on funds that embrace the concept in a more comprehensive way.

Toward a U.S. Sustainable Investment Policy

Sustainalytics’ Diederik Timmer moderated an interesting breakout session at the conference on the EU Sustainable Finance Action Plan. At one point, he asked the audience, seated at tables, to discuss amongst themselves for five minutes what policies might be appropriate in the U.S. and then report back to the entire group. Besides being a great way to make a conference panel more interactive, it got me to thinking about what a U.S. Sustainable Investment policy might entail.

Four things came mind:

Making ESG a required element of fiduciary duty (effect: increases assets in ESG investments, especially retirement plans)

Protection of shareholder rights (effect: defends active ownership from attacks from right-wing business lobbyists in D.C. by preserving the ability of shareholders to surface material risks)

Tax incentives for certain targeted sustainable investments (effect: drives more investment into areas of need — renewable energy, climate resilience, mobility, affordable housing, underdeveloped economies)

Company impact disclosure (effect: clarity on the costs of externalities, encourages long-termism and positive corporate purpose)

I know that impact disclosure may seem like a stretch, and the more-common call is for required ESG disclosure, but impact disclosures would force companies to evaluate their negative and positive externalities, which would not only help investors assess a company’s long-term risks and opportunities, it would also help policymakers and the public better understand the cost of subsidizing negative externalities. It may also nudge companies to address their externalities (mitigate the negatives, focus on the positives) to avoid further regulation and lead them to focus on their long-term vision.

Weekend Reads

Many U.S. companies are taking note of the urgency of recent climate reports and are changing corporate policies…

… And climate-aware investing is on the rise:

Abu Dhabi’s $800 billion sovereign-wealth fund recently added a new question to its investment process: How will the Earth’s changing climate affect a potential asset’s price? This addition, without fanfare or press release, was driven, fund officials say, by a fiduciary duty to earn the highest returns and avoid risks. It wasn’t an attempt to brand the fund as more “green.”

When Bayer bought Monsanto, it inherited Roundup weedkiller and thousands of lawsuits alleging that it causes cancer. Shareholders roundly disapproved at this year’s company meeting, with more than half refusing to endorse management’s actions over the past year. Now, according to The Wall Street Journal, Bayer says it will:

cut its environmental impact by 30% by 2030 through new technologies and making weedkillers more precise, and that it would also be more transparent about the safety of its products.

Mainstreaming proxy voting. Now that you’ve read this far, let’s tie this in with the discussion of ESG consideration funds above. In addition to more funds considering ESG in security selection, we are also starting to see funds considering ESG more seriously in their proxy voting.

Barron’s notes that Parametric Portfolio Associates, which subadvises a slew of PIMCO equity funds, among others, as well as many institutional accounts, has harmonized its proxy voting so that it no longer votes one way on behalf of sustainable funds and another way on behalf of all the others. Its votes are now based for all funds on the principles it has used for sustainable funds.

Now that we have fund proxy votes data in-house at Morningstar, we’ll be taking a close look at how funds vote this fall after August 31, when funds have to report their votes from this year’s proxy season.