Plan fiduciaries are seeing increased interest in social, or impact, investing as an option in their plan offerings. We have witnessed the evolution of socially responsible investing (SRI) from being just a consideration of avoiding companies that profit from “sin” (alcohol, tobacco, gambling, firearms, etc.) to a holistic focus on environmental, social, and governance (ESG) factors as integral to an investment strategy.
To be good stewards of capital, advanced knowledge of the benefits and significance of sustainability in investing―aligning with values―is essential. It is especially important to the Millennial generation, and is consistent with the importance many institutions place on social responsibility as part of their greater mission.
A growing body of research suggests that companies with a holistic consideration of ESG measures have better long-term financial outcomes and subsequently may provide more opportunities for profitable endeavors. For example, University of Oxford’s 2015 study, reviewed in the report From the Stockholder to the Stakeholder―How Sustainability Can Drive Financial Outperformance finds “a remarkable correlation between diligent sustainability business practices and economic performance.” The study found that companies’ solid ESG practices lead to better operational performance, in turn leading to improved cash flow and a positive impact on investment performance.
ESG and SRI are not asset classes; a prudent fiduciary must still value potential investments based on their fundamentals and compared to peers within their respective asset classes. Thorough due diligence is still required. The U.S. Department of Labor released a Field Assistance Bulletin (FAB) in April 2018, indicating that plan sponsors cannot sacrifice their fiduciary duty to the participant solely for a social cause. The FAB states: “A fiduciary’s evaluation of the economics of an investment should be focused on financial factors that have a material effect on the return and risk of an investment based on appropriate investment horizons consistent with the plan’s articulated funding and investment objectives.”
While not mutually exclusive, investment outcomes (return and risk) in retirement plans must override social objectives. Traditional analysis, with an eye to economic considerations, must still be inputs for all investment decisions. Sustainability may be incorporated into the investment process, but without compromising performance.
Sustainable investing is going mainstream. In fact, in June 2018, Goldman Sachs launched an exchange-traded fund (ETF) built on social impact metrics. The ETF scores businesses based on how they treat their employees, the environment, their products, customers, and other factors.
As interest in sustainable investing is growing, Morningstar launched a system for mutual fund sustainability ratings in 2016. This tool evaluates how well the companies included within the funds’ portfolios are managing their risks and opportunities relative to ESG factors. The ratings are applied across all funds, not just those that self-identify as socially responsible.
BlackRock, the world’s largest asset manager, believes that companies scoring well on ESG metrics also tend to be more resilient to ethical and climate-related debacles, and may offer some cushion during market declines. BlackRock’s founder and CEO, Laurence Fink, wrote in his most recent annual letter to CEOs: “To prosper over time, every company must not only deliver financial performance, but also show how it makes a positive contribution to society.”
The conversation has begun and is gaining traction around the world.
Karen Kaufman-White is a CIPM with Strategic Benefit Services.