Adoption of ESG investment criteria accelerates with asset owners

Foundations, endowments and public pension funds lead the charge into ESG strategies.

By Richard Schwartz

In 2018, some 43% of US institutional investors have incorporated environmental, social, and governance (ESG) factors into their investment decision-making process, according to the sixth annual ESG survey by Callan, an institutional investment consulting firm.

This percentage has almost doubled since the survey was first launched in 2013. After plateauing in 2017 (37%), a re-emergence of the upward trend in ESG adoption rates was evident in this year’s survey.

The ESG Survey features the responses of 89 unique U.S. institutional funds.

However, the headline figure nevertheless masks significant disparities in ESG adoption rates by fund type and size. Historically, endowments and foundations have consistently had the highest ESG adoption rates and this remains the case. Around 64% of foundations have incorporated ESG factors into investment decisions, according to the 2018 survey. Foundations have incorporated ESG factors at a higher rate than all other fund types in four out of the six years that Callan has run the survey. Endowments incorporated ESG factors at a rate of 56%—more than double the rate in 2013 (22%).

Public funds meanwhile have incorporated ESG factors into their investment decision-making process at a higher rate than their corporate counterparts. The latter has recorded the most modest rise in ESG adoption rates over the lifetime of the survey, from 14% in 2013 to 20% in 2018. Currently, 39% of public funds in the survey sample incorporate ESG criteria, up from 15% in 2013.

There was a significant difference between ESG adoption rates among defined benefit (DB) and defined contribution (DC) plans. Corporate DB plans incorporated ESG factors into the investment decision-making process at three times the rate of their DC counterparts (9%). Similarly, public DB plans employed ESG criteria at twice the rate (43%) of their DC counterparts (20%).

“The research and data supporting ESG investment have matured considerably in the past five years in the US and investors are now more informed about what ESG means and the implementation options available to them,” said Anna West, senior vice president and co-manager of Callan’s Published Research Group.

“The latest survey reinforces the notion that ESG is not a one-size-fits-all solution. Rather, investors are finding implementation approaches that match their funds’ goals. The shift in implementation strategies—from introducing language to identify ESG goals and beliefs, to working with investment managers to implement those concepts—suggests we’re moving into a new phase with ESG in the U.S.”

Implementation approaches identified in the 2018 survey reflect a new phase of ESG incorporation. Previously, investors focused more on pursuing education and adding ESG language to investment policy statements. In 2018, 55% of those implementing ESG have communicated its importance to investment managers and have considered ESG factors with every investment/investment manager selection.

The top ESG implementation methods for 2018 focus on the investment management community, including making clear the importance of ESG factors with every investment/investment manager selection (55%) and communicating to investment managers the importance of ESG to the fund (55%). Only 18% of respondents, however, score investment managers using ESG metrics, suggesting asset owners are still seeking a standardised and reliable method for measuring success in reference to ESG.

Although the motivations for incorporating ESG into investment decision-making were historically tied to moral or other non-financial convictions, the 2018 survey found that investors are increasingly focused on improved risk profile, fiduciary responsibility and maximising risk-adjusted returns.

According to Mark Mobius, founder of Mobius Capital Partners, which focuses on ESG investing in emerging markets, there is no real commonality as to what ESG criteria are top investors’ list of priorities.  “For example, some clients want a complete banning of anything related to fossil fuels (including oil), cigarettes, gaming and armaments while others are not as strict,” he told Global Custodian. “Also, in the corporate governance area there are wide differences on what should be done as regards to the number of independent directors, and more importantly, what the definition of ‘independent’ is.”