Sustainable Investing Opinion Briefs: December 31, 2018

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December 18, 2018 – An article by Kelsey Piper in Vox entitled “impact investment” funds advertise great returns and social impacts. They aren’t delivering” makes the case that impact investing, which is also referred to as socially responsible investing, is probably not making the world better. According to Kelsey, “Impact investing” is built on a simple idea: If you’re going to invest your money, you’ll want to invest it in companies that are doing work that you believe in. Easier access to capital lets companies do more — expand into new areas, build new products, take promising bets. Your investment would allow a company you believe in to do all those things.  It further goes on to note that “proponents claim that impact investing is good for the individual investor, too, with many funds advertising that they seek results for the world without sacrificing performance for the investor. In other words, according to Piper, they claim that impact investing won’t just do good — it will make you money. It’s not surprising that younger people seem to overwhelmingly want to invest their portfolios in socially responsible companies.  Yet the author concludes that “when you do the math, impact investing seems worse for the world and worse for your pocketbook than just investing traditionally, earning higher returns, and donating the difference. Impact investments are often marketed as a cost-free way of doing good. But they’re not cost-free, and under typical circumstances it doesn’t look like they’re doing much good.” A key reference used for this reporting is an in-depth report on impact investing release in mid-December by John Halstead of Fouder’s Pledge and Hauke Hillebrandt of the Center of Global Development.  An important conclusion of the report is that there is a trade-off between financial returns and social impact and that its nearly impossible to achieve market rate returns through impact investing. In our opinion, this article as well as the one covered below highlight the need for sustainable investing definitions, standards, disclosure and education.  Impact investing, which is a very small subset of sustainable investing, is being conflated with various other strategies more widely employed today.  In addition to impact investing, sustainable investing strategies range from socially responsible investing or values-based investing, that relies largely on an exclusionary approach and stands apart from impact investing, thematic investing, ESG integration, shareholder engagement and proxy voting.  While this formal definition is undergoing a re-examination by industry participants (see October 12: the International Finance Corp. (IFC) issued a Consultation Draft entitled “Investing for Impact: Operating Principles for Impact Management”), impact investing involves the allocation of capital to companies, organizations, and funds with the intention to achieve measurable social and environmental impacts alongside a financial return. While impact is essential, it is further defined by three core characteristics which, on a combined basis, serve to differentiate this strategy from other sustainable investing approaches, including socially responsible investing.  These include intentionality, return expectations that range from below market to risk adjusted market based and above and impact measurement.  Its unlikely that the three characteristics combined apply to any of the other sustainable strategies.  For example, employing an exclusionary strategy may not result in direct measurable positive outcomes and investing in green bonds represents a thematic investment option with positive environmental impacts that call for various disclosures before and during the investment period and that return market based financial results, but may not qualify as an impact investment on the basis of the additionality characteristic.

December 18, 2018 – In an article by Rachel Evans in Bloomberg BusinessWeek, the author posits that Wall Street’s embrace of ESG investing, in particular via the introduction of ESG oriented ETFs, has led to costlier products that are not very different than any standard index fund in terms of their holdings and in the end are not necessarily leading to a better world—an objective that appeals to millennials.  There has been a rush to market with new ETFs that have tripled in the US over the past three years but these according to one interviewee lack substance and are higher priced because asset managers can charge higher fees due to the additional work effort and generate more revenues.  Nuveen’s ETFs are singled out in particular on the basis of their expense ratios that at the low end carry a 0.2% fee versus 0.03% levied by the iShares Core S&P Total US Stock Market ETF.  Part of the problem is related to the way ESG funds are labeled given the lack of definitions and standardization regarding what constitutes ESG.  Another has to do with the fact that there is a lack of products aligned with investors’ particular priorities, such as worker welfare, an example that is offered in the article.    This, according to feedback shared with the author, is more important than performance which “wasn’t a primary reason in their decision-making.”  Given the nature of ETFS and the way they are structured, a disconnect arises when such ESG products are marketed “as a way for Americans to align their money with their values.”  It may be, concludes the author, that perhaps an approach to ESG investing that relies on the creation of separately managed accounts that allow investors to buy stocks around specific themes, like disease eradication, and exclude names they don’t like may be a better option for investors seeking to achieve positive societal outcomes.  Such as product is offered by Swell Investing.  We agree that definitions, standards, disclosure and education are very much needed, otherwise in our view investors will become disenchanted with sustainable investing.  This will help manage expectations and lead to positive outcomes.  As for fees, ESG index ETF expense ratios, on average, are 0.45%, or 0.08% lower than their non ESG counterparts. Nuveen’s 0.2% expense ratio applies to the US Aggregate Bond ETF.  These are generally more costly to run but even within the ESG segment, a lower priced alternative is available.

December 17, 2018 – An article from Benjamin Zycher and the America Enterprise Institute, a Washington D.C. think-tank, examines possible “conflicts” emulating from consultants advising ESG funds on proxy voting issues in particular.  The article, “Other People’s Money: ESG investing and conflicts of the consultant class” sees ESG investing as contributing to “the erosion of fund’s fiduciary responsibilities”.  Among other arguments, he feels that proxy voting inputs to asset managers by consulting services as well as, viewing ESG factors as “relevant” to performance represent inherent “conflicts of interest”.   We feel that most if not all asset managers – at least the ones we know and have worked with — build approaches and portfolios to generate maximum investment returns while avoiding risks.  This is no small task, and we believe that to suggest that sustainable investing involves political motives shows a lack of understanding why portfolio managers are hired in the first place.

December 14, 2018 – Summarizing a report by Cerulli, Jessa Claeys reports in the 401k Specialists that there are “3 Reasons ESG Investing Lags Behind Interests”.  Generally, about one-quarter of advisors feel that ESG does not fit their clients’ investment “policy”.  About the same percent are concerned about ESG portfolio performance, and costs considerations.  However, Cerulli feels that advisors “have not wholeheartedly adopted ESG” funds because they are behind in their waysWe are not convinced that this is the case.  We think that advisors may be less proactive when introducing new investment concepts to clients, because easier sales can be made.  This is especially likely if a client does not specifically ask for ESG investments.

December 13, 2018 — An article in the Financial Times by David Stevenson generally accuses the asset management industry of eschewing truly sustainable stances in its efforts to introduce ESG products.  In “ESG groupthink has captured the fund industry”, he suggests that funds’ coverage of ESG issues are selective and avoid certain “virtuous” causes.  He also suggests that the industry may even be “captured by liberal, educated global elite” with respect to the ESG issues and concerns they address in their approaches.  We think that the business, product planning, distribution, and regulatory environment in which asset managers operate prevents them from being all things to all people.  This is especially the case when it comes to a concept as intangible as sustainable values.  Further, before criticizing the fund industry, it’s important to remember that it is highly competitive and still in its early sustainable investment phases.

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