US continues to lag behind with ESG

The Unit­ed States is the world’s largest and deep­est mar­ket for investors, but when it comes to envi­ron­men­tal, social and gov­er­nance (ESG) invest­ing, it lags behind Europe. Accord­ing to a sur­vey by the Glob­al Sus­tain­able Invest­ment Alliance, Amer­i­ca had glob­al sus­tain­able assets of $11.9 tril­lion in 2018 com­pared to $14 tril­lion in Europe. Sus­tain­able invest­ing now makes up about 25 per cent of assets under man­age­ment, accord­ing to US SIF, the forum for sus­tain­able and respon­si­ble invest­ment.

The lag is not from a lack of inter­est in ESG. A sur­vey by asset man­ag­er Schroders shows more than 60 per cent of Amer­i­cans agree invest­ment funds should con­sid­er sus­tain­abil­i­ty fac­tors. Yet only 15 per cent say they put mon­ey in sus­tain­ably themed invest­ments.

Inter­est is par­tic­u­lar­ly strong among younger investors. Accord­ing to the Natix­is annu­al sur­vey of 401,000 plan par­tic­i­pants, 70 per cent of mil­len­ni­als say they would invest in plans for the first time or increase their con­tri­bu­tion rate if they had access to sus­tain­able invest­ment options.

While there has been increas­ing investor inter­est in ESG, the polit­i­cal and reg­u­la­to­ry envi­ron­ment is anoth­er sto­ry.

“You need three legs on a stool to bring about broad-based sup­port for ESG,” says Scott Kalb, founder and direc­tor of the Respon­si­ble Asset Allo­ca­tor Ini­tia­tive at New Amer­i­ca. There needs to be gen­er­al gov­ern­ment sup­port, a favourable reg­u­la­to­ry envi­ron­ment and lead­er­ship at the fund lev­el, he notes.

“In the Unit­ed States, we basi­cal­ly have one out of three. Organ­i­sa­tions have to be pret­ty brave to pur­sue ESG invest­ing,” he says.

Political and regulatory roadblocks to ESG investing

US reg­u­la­tion on ESG has gone back and forth a few times in the last cou­ple of decades, fluc­tu­at­ing between a neu­tral stance to active­ly dis­cour­ag­ing it.

The US Depart­ment of Labor (DoL) gave sus­tain­able invest­ing the green light back in 1994, posi­tion­ing it as a tiebreak­er between two oth­er­wise sim­i­lar funds. But then new guid­ance in 2008 made some fidu­cia­ries ner­vous to pur­sue ESG invest­ing. The guid­ance was updat­ed again in 2015 acknowl­edg­ing ESG can be an impor­tant mate­r­i­al fac­tor, which helped encour­age ESG invest­ing.

Now the tide has turned again and ESG invest­ing is fac­ing both polit­i­cal and reg­u­la­to­ry hur­dles. Under the Trump admin­is­tra­tion, the fed­er­al gov­ern­ment is dis­cour­ag­ing sus­tain­able invest­ing and envi­ron­men­tal pro­tec­tions. The admin­is­tra­tion has pulled out of the Paris Cli­mate Accord while rolling back envi­ron­men­tal reg­u­la­tions, appoint­ing for­mer coal lob­by­ist Andrew Wheel­er as head of the Envi­ron­men­tal Pro­tec­tion Agency.

Ear­li­er this year, the DoL pre­sent­ed a pro­pos­al that states fidu­cia­ries can fol­low ESG, but must prove that it’s cost effec­tive. The pro­pos­al, which is cur­rent­ly open for a com­ment peri­od until the end of July, would do much to dis­cour­age invest­ment man­agers from con­sid­er­ing ESG issues, says Meg Voorhes, direc­tor of research at US SIF.

“It could have the per­verse effect of mak­ing invest­ment man­agers not con­sid­er ESG, against fidu­cia­ry judg­ment,” says Vorhees. Man­agers know ESG fac­tors can be mate­r­i­al. But, she points out: “If I make it clear that we try to con­sid­er them that would invite scruti­ny from DoL and who needs that?”

Fear of lawsuits from low returns

In addi­tion to the less-than-sup­port­ive reg­u­la­to­ry envi­ron­ment in Amer­i­ca, there’s also the fear of back­lash from share­hold­ers. The risk of lit­i­ga­tion is an ever-present threat. The way reg­u­la­tions are writ­ten, the onus is on trustees to prove ESG invest­ing does indeed gen­er­ate bet­ter per­for­mance.

When CalPERS, the largest retire­ment plan in Amer­i­ca, tried to divest assault rifle retail­ers and whole­salers from its sys­tem, its board pres­i­dent was unseat­ed by a Cal­i­for­nia police sergeant who crit­i­cised CalPERS use of ESG as well as its mediocre returns. Sim­i­lar­ly, in New York, sev­er­al gov­ern­ment unions opposed the comptroller’s plan to dump fos­sil fuel invest­ments from the state’s pen­sion fund.

Much of the objec­tion to ESG invest­ing stems from an out­dat­ed per­cep­tion that embrac­ing ESG comes at a cost of finan­cial returns.

“There is a his­to­ry of think­ing about social­ly respon­si­ble invest­ments as things you don’t want to own that tends to lead to the per­cep­tion of under­per­for­mance,” says Ed Far­ring­ton, exec­u­tive vice pres­i­dent at Natix­is Invest­ment Man­agers. Reg­u­la­tors have tend­ed to take the same view and have not helped push for­ward oth­er strate­gies such as ESG inte­gra­tion.

ESG invest­ing has evolved dra­mat­i­cal­ly in the last decade, but many Amer­i­cans still believe it is only about divest­ment or screen­ing out cer­tain indus­tries such as tobac­co, alco­hol or muni­tions.

Mon­ey is mov­ing in this direc­tion and I don’t think they can stop it for some polit­i­cal rea­son

“The Unit­ed States has not moved to the next part, to impact-ori­ent­ed, pos­i­tive inte­gra­tion; that was a step Amer­i­ca has not tak­en,” says Jens Peers, chief exec­u­tive and chief invest­ment offi­cer for Miro­va US.

Despite the hur­dles, inter­est in ESG invest­ing is push­ing more man­agers to include ESG fac­tors. Some also see the coro­n­avirus pan­dem­ic as a turn­ing point for ESG as the cri­sis has high­light­ed the impor­tance of cor­po­rate respon­si­bil­i­ty and oth­er ESG fac­tors. Sus­tain­able funds saw a record $10.5 bil­lion of inflows in the first quar­ter, accord­ing to Morn­ingstar.

“I don’t think they can stem the tide. Mon­ey is mov­ing in this direc­tion and I don’t think they can stop it for some polit­i­cal rea­son,” Kalb con­cludes.