Part 1: Overview of the ESG Landscape
Overview of the ESG landscape, including key developments and high-level investor perspective (“setting the stage”)
As we approach the summer months and close Q2 books, we wanted to take the opportunity over the next four weeks to provide perspective on an important topic – ESG (Environmental, Social and Governance) – to help you “cut through the noise” and gain insights into an increasingly complex landscape. Over this timeframe, our series will focus on four key areas:
- Overview of the ESG landscape, including key developments and high-level investor perspective (“setting the stage”)
- Our primary research on ESG from the investor and corporate perspective
- Analysis of ESG mutual funds and investment firms to target
- Best practices and recommended strategies for effectively communicating ESG journeys
Setting the Stage
Over the past 12 years, we’ve conducted nearly 13,000 interviews with institutional investors and analysts on factors that impact valuation across an ever-growing foundation of more than 600 companies, spanning sectors, market-caps, profiles and special situations – one key component of this research has been the investor perspective on ESG. According to our most recent survey, comprising feedback from over 650 institutional investors and nearly 80 corporates globally, ESG continues to grow in importance and for an increasing number of investment firms. To be clear, ESG frameworks are becoming the standard to evaluate risk and opportunity.
Kicking off our series, my communication today starts at a high level and focuses on why all Board of Directors, C-Suite and IROs should care, including the increasing importance of ESG to institutional investors and key trends shaping the industry. With each subsequent week, we will provide more practical recommendations for implementation. Please let us know if there are any areas you are interested in and would like us to address.
Nearly Half of Institutional Investors Consider ESG Very Important to Their Investment Thesis, Up from Less Than One-Third in 2018
In early 2018, BlackRock Chairman and CEO Larry Fink published his groundbreaking (and, at that time, controversial) letter to CEOs, A Sense of Purpose, creating a shockwave across investment firms and corporate America. While our research identified a select group of investors that were incorporating ESG into their investment thesis, mainly firms in Europe, it wasn’t until the world’s largest asset manager gave the issue more credence that we saw a notable change in investor thinking. In it, Fink highlighted the firm’s “increasingly active approach to shareholder engagement, its view that boards are central in the oversight of companies’ long-term strategic direction,” and what he believes was “a connection between companies’ management of ESG risk factors and long-term value creation.” Long insulated and relatively inaccessible, governance became an even greater focus area and scrutiny continued to increase, as significant opportunity to drive value in this area was identified.
Initially met by both staunch advocates and naysayers, over time, the message became clear that ESG was here to stay, further built on by Fink’s 2019 and 2020 letters, Purpose & Profit and A Fundamental Reshaping of Finance, respectively, and solidified by the Business Roundtable’s release of a new Statement on the Purpose of a Corporation in August 2019, which saw a fundamental shift from “shareholder capitalism” to “stakeholder capitalism.”
Tracking views for over a decade, we have seen investors continue to evolve and increasingly incorporate ESG into their investment decisions. Indeed, 84% report ESG has grown in importance as an investment factor over the last two years. This marks a stark contrast to 2010, when only one in every five investors considered ESG important.
Since Larry Fink’s first annual letter, we have seen the percentage of institutional investors classifying ESG as Very Important to Critical to their investment thesis continue to increase, from less than one-third in 2018 to nearly half today (and more than double from a decade ago).
Ongoing Provider Consolidation is Further Shaping the ESG Landscape
According to our proprietary research, the leading service providers utilized by investors outside of internal resources are 1) Sustainalytics; 2) MSCI; 3) ISS, respectively, and to a much lesser extent Glass Lewis and RobecoSAM. In the past six months, we have seen significant consolidation in providers, including two of these top five resources. Our research finds the majority of investors utilize service provider research and ratings as only a starting point to a much more comprehensive analysis – both quantitative and qualitative – and, while a poor ESG rating does not automatically preclude the majority of investors surveyed from investing in a company, we think this will become a higher hurdle to receive internal approval going forward. According to investors:
- 22% say they ARE precluded from investing in the case of a poor ESG score
- 24% report they ARE NOT and can invest in whatever they deem appropriate for their fund
- 54% note it is CASE-SENSITIVE
No matter the case, consolidation in the ratings industry will create clear winners and losers, and we will continue to track which providers are the most widely utilized. The following are key acquisitions shaping the industry:
S&P Global Acquires ESG Ratings and Benchmarking Business from RobecoSAM (Jan. 10, 2020)- S&P Global and RobecoSAM, an affiliate of Robeco, announced that S&P Global acquired the ESG Ratings Business from RobecoSAM which includes the SAM* Corporate Sustainability Assessment (CSA) – an annual evaluation of companies’ sustainability practices. The ESG Ratings Business comprises two units: one administering the SAM CSA for the purpose of issuing ESG Ratings and a second that provides in-depth reports to companies seeking to understand their performance relative to their peers. The Company’s clients will now have access to proprietary and unique datasets based on information analyzing over 4,700 companies.
- Morningstar announced it reached an agreement to acquire Sustainalytics, the leading ratings provider according to our research. With this acquisition, Morningstar plans to continue to invest in Sustainalytics’ existing business while also further integrating ESG data and insights across Morningstar’s existing research and solutions for all segments, including individual investors, advisors, private equity firms, asset managers and owners, plan sponsors, and credit issuers.
ESG is Here to Stay – More than a Trend and Further Validated by COVID-19
Prior to COVID-19, net flows to ESG funds reached record levels, demonstrating clear traction with sustainable investing, especially with younger investors. In 2019, net flows to ESG funds in the U.S. topped $20 billion, compared with slightly over $5 billion the prior year and more than four times the amount in 2018 (Source: Morningstar), with approximately 300 mutual funds and ETFs now incorporating ESG as the focus, including five new sustainable funds launched by T. Rowe Price in April. These funds are based on some of T. Rowe Price’s existing portfolios and exclude companies whose business activities involve controversial weapons, assault-style weapons for civilian use, production of tobacco, production of thermal coal and adult entertainment, as well as companies with an extreme environmental, social, ethical or governance breach that are not taking credible steps to remediate the issue.
In total, sustainable mutual and ETFs held $137.3 billion in total assets at the end of 2019, though this is less than 1% of the $20.7 trillion held in the universe of mutual and ETF funds in the U.S. Entering 2020, this percentage was only expected to continue to increase but the coronavirus pandemic that caused a sharp market decline called into question ESG’s resiliency in a downturn for the first time.
Early results are in and they are clear: ESG passed the test and is here to stay. In Q1 2020, global sustainable mutual funds and ETFs brought in $40.5 billion in new assets, a 41% increase year-over-year, with U.S. sustainable funds attracting a record $7.3 billion (Source: BlackRock). BlackRock also observed better risk-adjusted performance across sustainable products globally, with 94% of a globally representative selection of widely analyzed sustainable indices outperforming their parent benchmarks. Furthermore, MSCI reported 15 of 17 of their sustainable indices outperformed broad market counterparts – robust across region and index methodology, and Morningstar reported 51 out of 57 of their sustainable indices outperformed their broad market counterparts and found that 70% of sustainable mutual funds performed in the top half of their respective categories.
While ESG mutual and ETF fund performance is clear, we know the harsh reality that COVID-19 has led to cutbacks in ESG spend at many corporations. Despite this, as we outlined in our “closing the quarter” thought leadership at the end of May, companies dramatically changed their messaging around the “Stakeholder” in 2020 versus the Great Recession of 2008-2009. In our review of earnings press releases and prepared remarks, we found that the leading message from CEOs was one of purpose and compassion, with emphasis placed on employees, customers, suppliers and business partners. Indeed, as of June 10, more than 1,000 companies globally referenced “stakeholder” on the most recent earnings call, compared to less than a tenth of that in 2008 and 2009.
Coupled with outperformance from ESG funds amid the COVID-19 pandemic, we believe sustainability is only going to increase in importance, and company messaging around the ‘S’ this quarter demonstrated the shift to stakeholder capitalism. We encourage all our clients to include sustainability as a pillar of corporate strategy and elevate it to the board level if not already doing so, ensuring that there is clear ownership and sponsorship through the organization, as what gets measured, gets done and the trick is in the doing.
In Closing
ESG is a complex landscape that continues to rapidly evolve and will for a long time – we believe companies that are committed to ESG, and sustainability more broadly, will be winners over the long haul, both in terms of attracting and retaining top talent and outperforming the market. And importantly, investors aren’t looking for perfection but rather progress; it’s a journey. Our ESG series over the next few weeks will dive deeper into the E, S and G, including insights into investor views and practical research and strategies – all with the goal of helping you successfully navigate ESG for maximizing impact.