In Many Ways, ESG Is Nothing New

While often spoken about as a new or emerging phenomenon, the practice of building portfolios that address environmental, social and governance concerns goes back to the late 19th century.

During the 2022 PLANSPONSONR ESG Essentials Seminar, held live in Orlando ahead of the 2022 PLANSPONSOR National Conference, Bonnie Saynay, the managing director of ISS ESG, provided a detailed history of the use of environmental, social and governance factors by institutional investors and their fund managers.

Saynay started by acknowledging that ESG is currently enjoying a moment in the institutional investor spotlight. Regulators in Washington, D.C., and in states across the union, are taking a close look at the development and distribution of ESG-focused investment products and services. Meanwhile, a significant portion of the U.S. investor population, across institutional and retail markets, say they want access to ESG-focused investment products and services.

However, the truth is that ESG investing, as a general matter, has roots going back more than a century. Saynay noted that, in 1898, the Friends Fiduciary Corporation launched a socially responsible investing fund that sought to meet the needs of Quaker investors concerned about firearms and alcohol. Later, in 1920, the Methodist Church in the United Kingdom started a program to help its members avoid certain types of “sinful” investments, and some 50 years later, the Pax World Fund was established with the goal of opposing militarism. When one looks back, Saynay said, the history is rich.

“So, suffice to say, the ESG issue has been evolving for a long time,” Saynay said. “One thing that is new, at least here in the United States, is the growing conviction that ESG investing is, in a sense, simply good investing. ESG investing is not about taking a values-based position. It is, in reality, the effort to take a full view of externalities and risks and how important factors could impact your returns.”

Of course, some ESG strategies involve negative screening that simply rejects certain stocks or entire sectors, potentially denting performance potential, but that’s not what ESG is all about in 2022, Saynay said. Instead, modern ESG investing is about leveraging the vast, rapidly growing pool of data and insights that pertain to factors directly impacting the performance of investment portfolios. Saynay listed off factors such as a company’s carbon footprint; its ability to manage waste; its impact on air quality and biodiversity; its water use; its impact on land degradation; its ability to attract and retain diverse talent; its ability to ensure good governance; its cybersecurity capabilities; and its transparency in corporate executive pay.

“As a point of reference, some 90% of S&P 500 companies are already disclosing ESG information in their recurring statements, and ESG issues are now a constant topic in earnings calls,” Saynay said.

When it comes to the retirement plan fiduciary’s perspective, Saynay said, some degree of caution when utilizing ESG is warranted, because the regulatory picture is complex and there are strict requirements for fiduciaries under the Employee Retirement Income Security Act. However, it is simply no longer the case that ESG is a fringe issue. Simply put, ESG factors are currently material to the performance of investment portfolios, and in that sense, plan fiduciaries may in fact have a duty to weigh the possibility of securing better performance by leveraging ESG considerations.

“Research also shows that about three-quarters of retirement plan participants surveyed say they would increase contributions if they could access ESG within their workplace savings plan,” Saynay said. “In addition, there is strong evidence that suggests retirement plan participants also have a greater, stronger connection with their workplace when the companies they work for speak about ESG issues and offer the opportunity to invest accordingly.”

Saynay said the ESG market of today is rapidly evolving, and there is particularly strong interest in the idea of “ESG integration.” As Saynay explained it, this approach sees asset managers utilize ESG data and frameworks to improve portfolio outcomes—rather than to achieve a particular social and environmental impact. Many asset managers are thus already directly coding ESG-focused information into the valuation models they utilize.

Speaking to the challenges associated with ESG implementation, Saynay pointed principally to the fluid and fast-expanding availability of potentially useful and economically material data.

“The opportunity set to use this data continues to grow at a rapid clip,” she explained. “One challenge stemming from this fact is that there is not any single governing body to help investors understand the information they are receiving or to help securities issuers know how they should be structuring and distributing such data.”

Saynay named as another challenge the difficulty of understanding how to work with third parties, such as assurance providers, which offer professional advice to companies on how to publicly disclose data and how to live up to the ESG promises they may have made to their clients.  

“From the asset manager perspective, if your trading system is supposed to be flagging something and it does not actually flag that development, that’s a problem,” Saynay said. “When it comes to ESG investing, due diligence and monitoring is so critical. You can’t just rely on fund names or representations without actually looking under the hood.”