While European institutional investors have incorporated environmental, social, and governance (ESG) considerations into their investment decision-making methodologies, the big American investors, for the most part, are lagging behind. Will they catch up – and are they even interested?
On the surface the figures are buoyant. In the Social Investment Forum’s tenth anniversary report on the socially responsible investment (SRI) trends in the US, the group found that SRI assets increased more than 258%, from $639bn (e524bn) in 1995 to $2.29trn in 2005 – this is contrasted with a growth in the broader universe of assets under professional management over the same period of less than 249%.
Of this total $2.29trn, according to SIF, some $1.49trn is investment assets held in socially screened accounts for institutions. The remainder is in retail products and commingled funds and accounts.
Among US institutional investors, public pension funds and employee retirement systems dominate the SRI landscape. More than 80% of all assets socially screened for institutional clients are managed for public funds or state and local investment pools, according to SIF. Corporate retirement plans and other investment portfolios lagged behind, amounting for only 10% of socially screened assets; endowments and foundations each hold between two and three% of socially screened assets managed for institutional investors.
Behind this good news, however, lies a potentially worrying trend – since 2003, SIF reports, in socially screened separate accounts, where institutional assets represent the lion’s share, “institutional client assets have declined somewhat as single-issue screening has waned and institutional investors have preferred to use shareholder advocacy to raise issue of concern, for example, through coalitions such as the Investor Network on Climate Risk…”
This is a dramatic contrast to the situation in Europe, where big institutional investors, including the large state pension funds, have adopted SRI considerations into their decision-making, and other institutional investors, including corporates, have followed suit. Eurosif estimated in 2003 that the SRI market in Europe amounted to more than E336bn
At its inception, SRI came out of the same roots both in Europe and the US. In both places, religious groups were at the vanguard of the movement and launched some of its earliest funds: for example, the Quaker- affiliated Friends Provident in the UK, the Ansvar Aktiefond Sverige, created by the Church of Sweden in Europe; or the Quakers and the Methodist Church in the US.
But also at its roots there were significant differences. SRI in its modern incarnation began in the US in the 1970s with the launch of funds such as the Pax World Fund and the Dreyfus Third Century Fund. This was a time of social unrest in the country, and the SRI movement was conceived alongside a number of protest movements, such as protests against military involvement in Vietnam, civil rights, and environmentalism.
In Europe, a modern form of SRI evolved a decade later, in the 1980s. Many of the earliest SRI vehicles there were “green” funds, and environmentalism has been more influential in Europe than it has been in the US.
From the late 1990s, SRI began to change again, as traditional institutional investors, such as pension funds and insurance companies, began adopting SRI methodologies – both in the US and Europe.
But it is in the last few years that the schism between Europe and the US has become apparent. For one, American asset managers are less convinced that SRI is an inevitability than are their European counterparts.
In its latest study of the US market, ‘Perspectives on responsible investment’, which was released in January this year, Mercer Investment Consulting found that “75% of respondents believe ESG factors can be material to investment performance, but less than half intend to access explicitly whether these factors are being considered.”
Jane Ambachtsheer, principal, Mercer Investment Consulting’s global responsible investment business, “took this as positive,” she told IPE. She sees the recognition of the materiality of SRI investing as a key development in the evolution of SRI toward becoming mainstream. “Once SRI was all about ethics. Now it has moved away from its narrow focus on ethical investment and there is a realisation that ESG considerations can impact investment performance.”
Mercer believes that ESG considerations will be integrated into investment decision-making, but “like any new idea it takes time from conceptualisation to actualisation,” Ambachtsheer said. “What we are starting to see is more effort to figure out how best to take the next step forward.” Mercer established its designated SRI research and consulting business only in 2004, and it was the first multinational consultancy to launch a dedicated unit.
Ambachtsheer sees an infrastructural difference between the US and Europe that might go some way toward explaining why the American institutional investors are lagging behind their European counterparts in adopting SRI methodologies. “It’s interesting how sustainable products vary between the US and Europe,” she said. “In the US, we see a lot of well-established SRI niche managers, who were the pioneers in the field, and who do a lot of very interesting work.”
She contrasted this with Europe, where many of the big asset management houses and funds have SRI groups within the organisation. “This has allowed an acceleration in the adoption of their ideas.” Ambachtsheer explained. “The analysis once done for use by the SRI teams is becoming an input in the overall investment decision-making, and the teams are working together more.”
This kind of integration is key to take SRI to the next level, Ambachtsheer maintains. “For integration, it can’t be SRI on the left, and ‘normal’ on the right.”
But for now, both in Europe and the US, the path to integration is a gradual one. According to the 2006 Fearless Forecast, its annual global survey on SRI, Mercer Investment Consulting found that “a significant proportion of managers anticipate increased demand for ESG factors to be integrated into investment processes.” Over 2006, 26% of European managers and 21% of UK managers see this to be the case – as opposed to only 8% of US managers. Over the medium term – the next three years, 39% of Europeans, and 42% of UK managers, believe that this will be the case, and the same is true for 35% of US managers. So in the medium term, the US market is catching up.
Both US and European managers anticipate less growth in interest in specialist investment strategies built on the analysis of ESG issues – so integration seems to be the way forward. In its analysis, Mercer says that, “Demand for standalone ESG strategies could depend on the rate at which ESG analysis is incorporated into mainstream investment processes. In particular, if managers move rapidly to incorporate ESG factors into their decision-making processes, because of client pressures or otherwise, then it is logical that the demand for standalone ESG strategies may be diminished.”
The difference in infrastructure is not the only factor that has historically held back the US in terms of SRI. The other big difference is that in Europe, there is much more interest on the part of governments and the citizenry in fostering engagement with SRI practices, noted Tim Smith, president of the SIF.
The legal framework for pension funds in many European countries requires that the funds publicly state their level of ESG engagement in their investment decision-making; the UK led the way with this in 1999, followed by man other countries, including Sweden. Germany, Belgium, Italy, Austria, the Netherlands, France, and Spain.
A recent study, co-authored by Lydenberg, CIO of Domini Social Investments, and Celine Louche of Vlerick Leuven Gent Management School states unequivocally that, “The active support of the European governments has in the effect of encouraging the traditional financial community of Europe to pursue this route in proportions that have no equivalent in the US.”
“In Europe, funds involved with SRI practices feel surrounded by multiple supportive constituencies,” SIF’s Smith said. “There is no government support here in the US.”
Speaking to IPE, Steve Lydenberg of Domini Social Investments, an independent firm with more than $1.8bn under management, concurred. “The implicit endorsement by states and state pension funds is huge – it makes all the difference in the world.” He pointed to sizeable funds, like the Norway Petroleum Fund, which is the largest pool of SRI-screened assets in the world.
“Even 10 years ago, the US was so far ahead. Now it’s a leapfrog effect. SRI has exploded in Europe, especially among mainstream institutional investors, not just the money managers,” Smith said.
Smith noted F&C’s well-established role in SRI in the UK, and the recent initiative by UBS as intriguing and significant private sector initiatives.
In December 2004, UBS set up an SRI team within its equity research division, with sell-side analysts looking at quantifying the effects of ESG issues on share prices. Its first report. ‘Why try to quantify the unquantifiable?’ was issued in April 2005 and establishes a framework to quantify corporate social liabilities, which it views as another financial claim on the business, alongside pension liabilities and debt.
And UBS is not the only big financial institution to put its name behind SRI research – Citigroup subsidiary Smith Barney issued an approach using qualitative methodologies, and Goldman Sachs applied quantititative methodologies to the analysis of the energy sector.
In contrast to these moves by big investors and big financial services firms, Lydenberg pointed out that in the US, “SRI has been driven by retail and small institutional investors, with the exception of divestment movements. On the retail side, SRI is mainstream.”
The South African divestment movement of the 1970s and 1980s has been followed by a similar move to divest of holdings that are involved in the Sudan. Some US states – Illinois, New Jersey, Oregon, and Louisiana - have legislation in this area, and others are expected to follow.
Domini’s Lydenberg sees differences not just on the level of infrastructure between the US and Europe. There are also national differences in the ways in which funds and asset managers engage with SRI practices. A big difference lies in shareholder advocacy. “Europeans are more comfortable talking things out behind the scenes,” he said, “whereas in the US, there is greater willingness to engage in public debate.”
In the US, institutional investors are increasingly becoming active shareholders, voting proxies and getting into debate and discussion with corporate leadership regarding ESG issues.
In the firms surveyed by Mercer Investment Consulting, for instance, 24% of respondents said that they planned to increase their proxy voting, and 27% intend to increase their shareholder engagement activity – and this is as true for corporates as it s for public funds and not-for-profits.
This is despite the fact that American corporates overall are far less swayed by the merits of SRI. In the survey, Some 14% of corporates currently invest in SRI – the same level as respondents from public funds – but only 1% admit to be planning to do so within the next few years. This compared with 6% of public funds who plan to engage in SRI practices in the short term.
The Mercer US survey also found that the largest US funds are the most likely to become active shareholders: more than two-thirds of those funds with $5bn or more under management are planning to increase their level of proxy voting and other engagement activities.
In addition, Lydenberg and Louche see differences in style between the US and Europe. In the US, for example, there is a greater stress on the values aspect of SRI investing, whereas in Europe the emphasis on the ways in which social and environmental issues interact with the bottom. In addition, the Americans make use of negative screening and exclusion strategies than do the Europeans. “This attitude reflects the manifest willingness of the Eruopeans to offer products acceptable to the institutional market, which is reluctant to particpate in activism or activities inspired by moral considerations,” write the authors.
Despite the differences between the US and European markets for SRI, it is clear that it is an area that is going to continue to grow and evolve. Louche and Lydenberg in their essay, maintain that current patterns are set to continue. “The SRI movements in the two regions will continue to pursue their shared objectives… However, these preoccupations will develop more rapidly within the traditional financial community in Europe than in the US and will probably be destined for the institutional market rather than retail clients there. In the US, the SRI players will continue to be outside traditional financial markets, and will adopt a more challenging and activist attitude to reach the same ends.”
To Lydenberg himself, being outside the mainstream does not mean being without influence. “In many regards, in terms of influence, it doesn’t need to be everybody. If 10% or 20% are influenced by ESG considerations, then its significant.