Issue 28: 2014

Special Section — ESG

ESG Investing Goes Mainstream

In a striking change from the recent past, environmental, social and governance principles offer investors greater potential to do well while doing good.

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It has a lot of names. For the purposes of this special section, we’re using the term environmental, social and corporate governance (ESG) investing, but you might use socially responsible investing (SRI), sustainable and responsible investing (also SRI), impact investing or something else. Labels aside, one thing is clear: Structuring a portfolio to help foster good corporate practices (e.g., lower greenhouse-gas emissions, ethically sourced raw materials, workforce diversity and more) has undergone a transformation.

ESG has changed. Here’s how:

  • Returns. There is a growing pool of data indicating that social responsibility can help corporations produce returns similar to broader market returns.1
  • Investment dollars. ESG is attracting a large pool of investors and, with them, more capital.2
  • Corporations. More corporations are focusing on ESG and finding it can help improve financial results.
  • Metrics. More companies are willing to publish metrics related to ESG issues.
  • Validity. More third-party organizations are checking the validity of corporate ESG metrics.

This presents a very different picture when compared with a decade or so ago. Back then, many investors viewed ESG investing as an underperforming niche activity involving unreliable or incomplete corporate data and pie-in-the-sky goals — and many avoided it completely. But that was then.

This special report looks closely at ESG investing, its performance, evolution and potential portfolio benefits, and why some investors still eschew ESG.

ESG Performance

The most significant change in ESG investing is performance. Companies that are focused on managing environmental, social and other factors may produce returns similar to those of companies that have few or no ESG components in place.3

As Chris Hyzy, chief investment officer at U.S. Trust, puts it: “We believe that corporations dealing effectively with environmental and other ESG issues are poised to do well, relative to their industry peers.”

Independent studies on sustainability and performance echo Hyzy. According to a 2014 report by McKinsey & Company, a management consulting firm, “a growing body of evidence indicates that sustainability initiatives can help to create profits and business opportunities” and that being “more efficient at using resources” is a strong indicator of “strong financial performance overall.”4

ESG indexes

Take a look at the “Sustainable Investing on Par” above, which shows the performance of two ESG-related indexes (one for the United States and one for the world) compared with equivalent non-ESG indexes. As you can see, whether it’s U.S.- or world-focused, ESG performance tracks closely with non-ESG. The major difference, of course, is that ESG-focused investing has more potential to bring positive change — environmental or otherwise. So, in a sense, with performance results being roughly equal, it boils down to one question: Do you want your investments to have the potential to help the planet?

Consumer and investor pressure

Companies are discovering that sustainable practices, such as using solar or wind energy or a more efficient production process, can help reduce their expenses and potentially grow their bottom line. They’re also finding that consumers may favor good corporate citizens — companies that use alternative energy, promote workplace diversity or purchase ethically sourced raw materials — which can also be good for the bottom line.

What’s more, for some time consumers have been pressuring companies to become more ESG-focused, and using social media to do so. In one recent notable instance, an activist group posted a video online criticizing a global food company for what the group said were unsustainable forest-clearing practices related to palm oil production in Indonesia. A few months later, almost certainly in response to the video, the company announced that by 2015 it would use only oil certified as sustainable.

Common Misperceptions About ESG

Some investors harbor misperceptions about ESG. Here are some of those ESG myths and corresponding ESG facts.

Common Misperceptions About ESG

Some investors harbor misperceptions about ESG. Here are some of those ESG myths and corresponding ESG facts.

Common Misperceptions About ESG

Some investors harbor misperceptions about ESG. Here are some of those ESG myths and corresponding ESG facts.

Common Misperceptions About ESG

Some investors harbor misperceptions about ESG. Here are some of those ESG myths and corresponding ESG facts.

Common Misperceptions About ESG

Some investors harbor misperceptions about ESG. Here are some of those ESG myths and corresponding ESG facts.

Investors, as well

But it’s not just consumers who are making a case for ESG integration: Investors are on a similar tack. In a recent report, US SIF, The Forum for Sustainable and Responsible Investment, an organization that tracks sustainable investing, said that, as a response to shareholders advocating for socially responsible investing, “global corporations increasingly embrace ESG practices and disclosure, and incorporate these standards into their operations.”5

What's in a Name?
When it comes to social investing, the plethora of labels can be perplexing.Click to expand

“Better product and operational safety standards, combined with better environmental stewardship, can make expensive lawsuits and fines less likely,” says Jason T. Baron, head portfolio manager for social investments at U.S. Trust. “In turn, in the marketplace, a more accountable company can help foster a solid reputation and can appeal to investors as well as consumers.”

When consumers and investors alike are putting pressure on companies to integrate environmental, social and corporate governance opportunities, it’s clear just how far ESG integration has traveled, from being an exception just a decade ago to being almost business as usual today.

Bad press

What can happen when a company ignores ESG practices? Their bottom line may suffer. If a corporation fails to limit its carbon production, for example, it may be slapped with a regulatory fine. If consumers react to a company’s workforce diversity issues, sales may drop.

According to the McKinsey report, combined losses from regulatory fines and sales slowdowns could lead to a 70% decline in EBITDA (earnings before interest, taxes, depreciation and amortization); meanwhile, failure to use raw materials more sparingly in a time of rising prices could mean a 65% drop in EBITDA. (See “Low or Zero Sustainability” chart, below.)

Reliable data

One apparent deal breaker for many investors in the past was the unreliability of corporate ESG metrics. Not only was data inconsistent, critics said, there were few ways to separate fact from fiction. These days, more corporations are reporting reliable ESG metrics: The Global Reporting Initiative (GRI) framework reports that thousands of companies worldwide use GRI’s standards for reporting on sustainability, in areas such as ecological footprint and corporate social responsibility. In addition, more prominence is given to companies such as GMI Ratings (part of MSCI Inc.), which checks the authenticity of metrics.

Wider acceptance

Investors have turned to ESG in greater numbers over the last decade — especially in the past few years. This is reflected in the rise in assets under management (AUM) committed to responsible investing, which grew from about $639 billion in 1995 to $3.74 trillion in 2012. Between 2010 and 2012, assets grew by 20%.6

The growing acceptance of ESG can also be seen in the rise in the number of signatories to the United Nations Principles for Responsible Investment (UN PRI), an initiative for investment organizations with a focus on ESG issues. There were six members in 2006 and more than 1,200 in 2013.7

Who are the future ESG investors?

Several demographic shifts (they are one part of what U.S. Trust and Bank of America are calling the “Five Forces of Global Change”) bode well for ESG’s continuing move into the investment mainstream. “Women and young people appear to be gravitating toward more meaningful investing at a rate that’s higher than that for other traditional investors,” says Jackie VanderBrug, an investment strategist at U.S. Trust. “In a recent survey of high-net-worth individuals, slightly more than half of the respondents said that the social and environmental impact of their investments was important. But for women and millennials the rate was 73%.”8

With these data points in mind, looking to the future — as more women gain more control of family investments or become wealthy investors in their own right; and as today’s 20- to 30-year-olds become wealthier and more avid investors with age — ESG investing could well become simply the way most people invest. Says U.S. Trust’s Jason Baron: “We think a time will come, and it’s not too far away, when no discernible distinction will exist between investors in ESG and investors in general. We believe that eventually there will simply be ‘investing.’ ”

ESG evolution

Before a decade ago, those who wanted ESG-related investments had basically one option: a centuries-old exclusionary investment practice — often dubbed negative screening — that was first used by religious groups in the 1800s or earlier. This strategy screens out companies that manufacture products or provide services you might object to (e.g., weapons, cigarettes, alcohol or gambling) irrespective of how those companies perform.

Although with careful portfolio construction it is possible to attain positive returns with negative screening, the strategy was prone to underperformance. Indeed it was chiefly this trait that gave socially responsible investing a bad name in investment circles. (Some organizations choose to phase out entire industries. One fund, a philanthropic concern founded on vast wealth made in the oil industry, just this year announced plans to divest all stocks related to fossil fuels.)

ESG today

ESG has evolved rapidly. Nowadays it is far more nuanced and sophisticated. Along with negative screening, a range of investment strategies — including social and ethical, environmental and faith-based — fall under the umbrella of ESG strategies.

And while some investors may still use negative screening to factor out a company or an industry that doesn’t jibe with their values or principles, many can now also choose to include companies with the potential to do well while doing good. This is a quite a switch. As Joseph Quinlan, chief market strategist at U.S. Trust, notes: “Searching for companies that are engaged in positive environmental, social and governance practices, and are likely to be profitable while doing so — that’s a significant change from the way it used to be.”

Sustainability in a changing world

Corporate sustainability could make more and more financial sense in time. Here’s why. The world is being reshaped by immense forces — what U.S. Trust and Bank of America are calling the “Five Forces of Global Change.” Chief among them is a population that’s not only living longer, due largely to medical advances, but also expanding, from 7 billion people today to a projected 9 billion in 2050, according to the United Nations’ 2013 data. Then, there’s the growing wealth in emerging markets, which is giving rise to middle classes with tastes for Western-style consumerism and high-protein diets. (The Five Forces of Global Change are discussed in more depth in a later section.)

Engaging Workers
S (social) and G (governance) strategies in practice.Click to expand

“This combination of population growth and middle-class growth is complicating the global competition for natural resources,” Hyzy says. “It’s energy. But it’s also water and raw materials and agricultural commodities.”

In the face of rising competition for resources, and what is almost certainly an accompanying rise in prices, companies are all but guaranteed to see their overhead costs climb. “Seen in that light, sustainability — or being more vigilant about the use of energy, water, resources and more — just makes sound financial sense,” Hyzy says.

In a similar vein, Saad Rashid, investment director at Osmosis Investment Management, an investment group with an ESG focus, says, “We search each sector of the economy…for the most resource-efficient companies because our research has shown that, when compared with less efficient companies, they often generate a greater return on assets, a greater enterprise value and greater shareholder value.”

ESG and the Five Forces of Global Change

Change is occurring on a virtually unprecedented scale. Indeed, says Quinlan, “the world is very different today, and it is likely to keep changing at a rapid pace for the foreseeable future.” Here are a few examples of the kinds of transformations under way today:

  • The global population passed the 7 billion mark in 2011, and is now headed toward 9 billion by mid-century, according to United Nations projections.
  • Middle classes are rising in geographical areas long associated with abject poverty.
  • Technology and biotechnology are altering how, and how long, we live.
  • Water and other natural resources are becoming constrained in certain parts of the United States and in countries such as China.
  • Man-made carbon pollutants continue to increase concerns about changes in the Earth’s climate.

To put this ongoing global shift into perspective, and to make what’s behind it fundamentally easier to grasp, U.S. Trust and Bank of America are using a categorization called the Five Forces of Global Change. The five forces are People, Earth, Innovation, Markets and Government.

How does ESG mesh with the Five Forces? And where might anyone planning to invest responsibly search for opportunities of the kind the Five Forces are likely to generate?

Says Quinlan: “ESG investors often seek companies that promote the efficient use of resources, especially water and energy, or are reducing their carbon footprint. That certainly fits well with the Earth category in the Five Forces. As for the Innovation category, we’ve found that innovative companies are likely to be ahead of the curve in terms of key ESG themes. In the People category, there are companies that focus on demographics and diversity as key human rights issues.”

As the Five Forces continue to change the world, in ways both large and small, Quinlan says, “we believe that companies able to adapt, by becoming more efficient or more diverse or by reducing waste, stand to perform well over the long term.”

Next steps in ESG investing

If you’re interested in finding out more about investing with a focus on ESG practices, including how it might align with your personal values or whether it might be appropriate for your overall investment portfolio, be sure to talk with your investment advisor. To read about four specific investment approaches that are available on the U.S. Trust platform, see the ESG Strategies sections throughout this article.

 

 

1 Between September 2007 and August 2014, MSCI World ESG Index rose 130.40% and MSCI World Index rose 129.41%. MSCI, August 31, 2014

2 Sustainable and Responsible Investing Trends in the United States, US SIF Foundation, 2012. (Latest available data.)

3 Between September 2007 and August 2014, MSCI World ESG Index rose 130.40% and MSCI World Index rose 129.41%. MSCI, August 31, 2014

4 Profits with Purpose: How Organizing for Sustainability Can Benefit the Bottom Line, McKinsey & Company, July 2014.

5 Sustainable and Responsible Investing Trends in the United States, US SIF Foundation, 2012. (Latest available data.)

6 Sustainable and Responsible Investing Trends in the United States, US SIF Foundation, 2012. (Latest available data.)

7 Signatories to the Principles for Responsible Investment, UN PRI, 2013.

8 2014 U.S. Trust Insights on Wealth and Worth®, ustrust.com/survey.

IMPORTANT INFORMATION

Investing involves risk. There is always the potential of losing money when you invest in securities.

Some of the featured participants are not employees of U.S. Trust. The opinions and conclusions expressed are not necessarily those of U.S. Trust or its personnel. Any of their discussions concerning investments should not be considered a solicitation or recommendation by U.S. Trust and may not be profitable.

Projections made may not come to pass due to market conditions and fluctuations.

Past performance is no guarantee of future results.

Always consult with your independent attorney, tax advisor, investment manager and insurance agent for final recommendations and before changing or implementing any financial, tax or estate planning strategy.

OTHER IMPORTANT INFORMATION

Equities
Equity securities are subject to stock market fluctuations that occur in response to economic and business developments.

Stocks of small and mid cap companies pose special risks, including possible illiquidity and greater price volatility, than stocks of larger, more established companies.

Fixed Income
Investing in fixed-income securities may involve certain risks, including the credit quality of individual issuers, possible prepayments, market or economic developments, and yields and share price fluctuations due to changes in interest rates. When interest rates go up, bond prices generally drop, and vice versa.

There may be less information available on the financial condition of issuers of municipal securities than for public corporations. The market for municipal bonds may be less liquid than for taxable bonds. Tax-exempt investing offers current tax-exempt income, but it also involves special risks. Income from investing in municipal bonds is generally exempt from federal and state taxes for residents of the issuing state. Interest income from certain tax-exempt bonds may be subject to certain state and local taxes and, if applicable, the alternative minimum tax (AMT).

International Investing
International investing involves special risks, including foreign taxation, currency risks, risks associated with possible differences in financial standards, and other risks associated with future political and economic developments. Investing in emerging markets may involve greater risks than investing in more developed countries. In addition, concentration of investments in a single region may result in greater volatility.

Commodities
Trading in commodities, such as gold, is speculative and can be extremely volatile. There are special risks associated with an investment in commodities, including market price fluctuations, regulatory changes, interest-rate changes, credit risk, economic changes and the impact of adverse political or financial factors. Tangible assets can fluctuate with supply and demand, such as commodities, which are liquid investments, unlike most other tangible investments.

Energy and natural resources stocks have been volatile. They may be affected by rising interest rates and inflation, and can also be affected by factors such as natural events (for example, earthquakes or fires) and international politics.

Alternative Investments
Alternative investments are intended for qualified and suitable investors only. Alternative investments are speculative and involve a high degree of risk. Alternative investments such as derivatives, hedge funds, private equity funds and funds of funds can result in higher return potential but also higher loss potential. Changes in economic conditions or other circumstances may adversely affect your investments. Before you invest in alternative investments, you should consider your overall financial situation, how much money you have to invest, your need for liquidity and your tolerance for risk.

Real Estate Investment Trusts (”REITs”) involve a significant degree of risk and should be regarded as speculative. They are only made available to qualified investors under the terms of a private offering memorandum. Holdings in a REIT may be highly leveraged and, therefore, more sensitive to adverse business or financial developments. REITs are long term and unlikely to produce a realized return for investors for a number of years. Investments in real estate securities can be subject to fluctuations in the value of the underlying properties, the effect of economic conditions on real estate values, changes in interest rates and risks related to renting properties, such as rental defaults.

Technology stocks may be more volatile than stocks in other sectors.

The 2014 U.S. Trust Insights on Wealth and Worth® survey is based on a nationwide survey of 680 high-net-worth and ultra-high-net-worth adults with at least $3 million in investable assets, not including the value of their primary residence. Respondents were equally divided among those who have between $3 million and $5 million, $5 million and $10 million, and $10 million or more in investable assets. The survey was conducted online by the independent research firm Phoenix Marketing International in February and March of 2014. Asset information was self-reported by the respondent. Verification for respondent qualification occurred at the panel company, using algorithms in place to ensure consistency of information provided, and was confirmed with questions from the survey itself. All data have been tested for statistical significance at the 95% confidence level.

The MSCI KLD 400 Social Index sources the MSCI USA IMI ESG Index, which is made up of securities of large, mid and small cap U.S. companies selected using an ESG best-in-class methodology. Companies involved in the following activities are excluded from the selection universe: alcohol, gambling, tobacco, military weapons, civilian firearms, nuclear power, adult entertainment and genetically modified organisms (GMOs). The MSCI KLD 400 Social Index is designed to maintain similar sector weights as the MSCI USA Index and targets a minimum count of 200 large and mid cap constituents. The MSCI USA Index is a free-floating adjusted market capitalization index that is designed to measure large and mid cap U.S. equity market performance. The MSCI USA Index is member of the MSCI Global Equity Indices and represents the U.S. equity portion of the global benchmark MSCI ACWI Index. The MSCI World ESG Index is a capitalization weighted index that provides exposure to companies with high environmental, social and governance (ESG) performance relative to their sector peers. MSCI World ESG consists of large and mid cap companies in 23 Developed Markets (DM) countries. The index is designed for investors seeking a benchmark comprised of companies with strong sustainability profiles and relatively low tracking error to the underlying equity market. The MSCI World Index captures large and mid cap representation across 23 Developed Markets (DM) countries. With 1,615 constituents, the index covers approximately 85% of the free float–adjusted market capitalization in each country.

 


Plain Picture/Imagesource

 

It has a lot of names. For the purposes of this special section, we’re using the term environmental, social and corporate governance (ESG) investing, but you might use socially responsible investing (SRI), sustainable and responsible investing (also SRI), impact investing or something else. Labels aside, one thing is clear: Structuring a portfolio to help foster good corporate practices (e.g., lower greenhouse-gas emissions, ethically sourced raw materials, workforce diversity and more) has undergone a transformation.

ESG has changed. Here’s how:

  • Returns. There is a growing pool of data indicating that social responsibility can help corporations produce returns similar to broader market returns.1
  • Investment dollars. ESG is attracting a large pool of investors and, with them, more capital.2
  • Corporations. More corporations are focusing on ESG and finding it can help improve financial results.
  • Metrics. More companies are willing to publish metrics related to ESG issues.
  • Validity. More third-party organizations are checking the validity of corporate ESG metrics.

This presents a very different picture when compared with a decade or so ago. Back then, many investors viewed ESG investing as an underperforming niche activity involving unreliable or incomplete corporate data and pie-in-the-sky goals — and many avoided it completely. But that was then.

This special report looks closely at ESG investing, its performance, evolution and potential portfolio benefits, and why some investors still eschew ESG.

ESG Performance

The most significant change in ESG investing is performance. Companies that are focused on managing environmental, social and other factors may produce returns similar to those of companies that have few or no ESG components in place.3

As Chris Hyzy, chief investment officer at U.S. Trust, puts it: “We believe that corporations dealing effectively with environmental and other ESG issues are poised to do well, relative to their industry peers.”

Independent studies on sustainability and performance echo Hyzy. According to a 2014 report by McKinsey & Company, a management consulting firm, “a growing body of evidence indicates that sustainability initiatives can help to create profits and business opportunities” and that being “more efficient at using resources” is a strong indicator of “strong financial performance overall.”4

ESG indexes

Take a look at the “Sustainable Investing on Par” above, which shows the performance of two ESG-related indexes (one for the United States and one for the world) compared with equivalent non-ESG indexes. As you can see, whether it’s U.S.- or world-focused, ESG performance tracks closely with non-ESG. The major difference, of course, is that ESG-focused investing has more potential to bring positive change — environmental or otherwise. So, in a sense, with performance results being roughly equal, it boils down to one question: Do you want your investments to have the potential to help the planet?

Consumer and investor pressure

Companies are discovering that sustainable practices, such as using solar or wind energy or a more efficient production process, can help reduce their expenses and potentially grow their bottom line. They’re also finding that consumers may favor good corporate citizens — companies that use alternative energy, promote workplace diversity or purchase ethically sourced raw materials — which can also be good for the bottom line.

What’s more, for some time consumers have been pressuring companies to become more ESG-focused, and using social media to do so. In one recent notable instance, an activist group posted a video online criticizing a global food company for what the group said were unsustainable forest-clearing practices related to palm oil production in Indonesia. A few months later, almost certainly in response to the video, the company announced that by 2015 it would use only oil certified as sustainable.

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Investors, as well

But it’s not just consumers who are making a case for ESG integration: Investors are on a similar tack. In a recent report, US SIF, The Forum for Sustainable and Responsible Investment, an organization that tracks sustainable investing, said that, as a response to shareholders advocating for socially responsible investing, “global corporations increasingly embrace ESG practices and disclosure, and incorporate these standards into their operations.”5

What's in a Name?
When it comes to social investing, the plethora of labels can be perplexing.Click to expand

“Better product and operational safety standards, combined with better environmental stewardship, can make expensive lawsuits and fines less likely,” says Jason T. Baron, head portfolio manager for social investments at U.S. Trust. “In turn, in the marketplace, a more accountable company can help foster a solid reputation and can appeal to investors as well as consumers.”

When consumers and investors alike are putting pressure on companies to integrate environmental, social and corporate governance opportunities, it’s clear just how far ESG integration has traveled, from being an exception just a decade ago to being almost business as usual today.

Bad press

What can happen when a company ignores ESG practices? Their bottom line may suffer. If a corporation fails to limit its carbon production, for example, it may be slapped with a regulatory fine. If consumers react to a company’s workforce diversity issues, sales may drop.

According to the McKinsey report, combined losses from regulatory fines and sales slowdowns could lead to a 70% decline in EBITDA (earnings before interest, taxes, depreciation and amortization); meanwhile, failure to use raw materials more sparingly in a time of rising prices could mean a 65% drop in EBITDA. (See “Low or Zero Sustainability” chart, below.)

Reliable data

One apparent deal breaker for many investors in the past was the unreliability of corporate ESG metrics. Not only was data inconsistent, critics said, there were few ways to separate fact from fiction. These days, more corporations are reporting reliable ESG metrics: The Global Reporting Initiative (GRI) framework reports that thousands of companies worldwide use GRI’s standards for reporting on sustainability, in areas such as ecological footprint and corporate social responsibility. In addition, more prominence is given to companies such as GMI Ratings (part of MSCI Inc.), which checks the authenticity of metrics.

Wider acceptance

Investors have turned to ESG in greater numbers over the last decade — especially in the past few years. This is reflected in the rise in assets under management (AUM) committed to responsible investing, which grew from about $639 billion in 1995 to $3.74 trillion in 2012. Between 2010 and 2012, assets grew by 20%.6

The growing acceptance of ESG can also be seen in the rise in the number of signatories to the United Nations Principles for Responsible Investment (UN PRI), an initiative for investment organizations with a focus on ESG issues. There were six members in 2006 and more than 1,200 in 2013.7

Who are the future ESG investors?

Several demographic shifts (they are one part of what U.S. Trust and Bank of America are calling the “Five Forces of Global Change”) bode well for ESG’s continuing move into the investment mainstream. “Women and young people appear to be gravitating toward more meaningful investing at a rate that’s higher than that for other traditional investors,” says Jackie VanderBrug, an investment strategist at U.S. Trust. “In a recent survey of high-net-worth individuals, slightly more than half of the respondents said that the social and environmental impact of their investments was important. But for women and millennials the rate was 73%.”8

With these data points in mind, looking to the future — as more women gain more control of family investments or become wealthy investors in their own right; and as today’s 20- to 30-year-olds become wealthier and more avid investors with age — ESG investing could well become simply the way most people invest. Says U.S. Trust’s Jason Baron: “We think a time will come, and it’s not too far away, when no discernible distinction will exist between investors in ESG and investors in general. We believe that eventually there will simply be ‘investing.’ ”

ESG evolution

Before a decade ago, those who wanted ESG-related investments had basically one option: a centuries-old exclusionary investment practice — often dubbed negative screening — that was first used by religious groups in the 1800s or earlier. This strategy screens out companies that manufacture products or provide services you might object to (e.g., weapons, cigarettes, alcohol or gambling) irrespective of how those companies perform.

Although with careful portfolio construction it is possible to attain positive returns with negative screening, the strategy was prone to underperformance. Indeed it was chiefly this trait that gave socially responsible investing a bad name in investment circles. (Some organizations choose to phase out entire industries. One fund, a philanthropic concern founded on vast wealth made in the oil industry, just this year announced plans to divest all stocks related to fossil fuels.)

ESG today

ESG has evolved rapidly. Nowadays it is far more nuanced and sophisticated. Along with negative screening, a range of investment strategies — including social and ethical, environmental and faith-based — fall under the umbrella of ESG strategies.

And while some investors may still use negative screening to factor out a company or an industry that doesn’t jibe with their values or principles, many can now also choose to include companies with the potential to do well while doing good. This is a quite a switch. As Joseph Quinlan, chief market strategist at U.S. Trust, notes: “Searching for companies that are engaged in positive environmental, social and governance practices, and are likely to be profitable while doing so — that’s a significant change from the way it used to be.”

Sustainability in a changing world

Corporate sustainability could make more and more financial sense in time. Here’s why. The world is being reshaped by immense forces — what U.S. Trust and Bank of America are calling the “Five Forces of Global Change.” Chief among them is a population that’s not only living longer, due largely to medical advances, but also expanding, from 7 billion people today to a projected 9 billion in 2050, according to the United Nations’ 2013 data. Then, there’s the growing wealth in emerging markets, which is giving rise to middle classes with tastes for Western-style consumerism and high-protein diets. (The Five Forces of Global Change are discussed in more depth in a later section.)

Engaging Workers
S (social) and G (governance) strategies in practice.Click to expand

“This combination of population growth and middle-class growth is complicating the global competition for natural resources,” Hyzy says. “It’s energy. But it’s also water and raw materials and agricultural commodities.”

In the face of rising competition for resources, and what is almost certainly an accompanying rise in prices, companies are all but guaranteed to see their overhead costs climb. “Seen in that light, sustainability — or being more vigilant about the use of energy, water, resources and more — just makes sound financial sense,” Hyzy says.

In a similar vein, Saad Rashid, investment director at Osmosis Investment Management, an investment group with an ESG focus, says, “We search each sector of the economy…for the most resource-efficient companies because our research has shown that, when compared with less efficient companies, they often generate a greater return on assets, a greater enterprise value and greater shareholder value.”

ESG and the Five Forces of Global Change

Change is occurring on a virtually unprecedented scale. Indeed, says Quinlan, “the world is very different today, and it is likely to keep changing at a rapid pace for the foreseeable future.” Here are a few examples of the kinds of transformations under way today:

  • The global population passed the 7 billion mark in 2011, and is now headed toward 9 billion by mid-century, according to United Nations projections.
  • Middle classes are rising in geographical areas long associated with abject poverty.
  • Technology and biotechnology are altering how, and how long, we live.
  • Water and other natural resources are becoming constrained in certain parts of the United States and in countries such as China.
  • Man-made carbon pollutants continue to increase concerns about changes in the Earth’s climate.

To put this ongoing global shift into perspective, and to make what’s behind it fundamentally easier to grasp, U.S. Trust and Bank of America are using a categorization called the Five Forces of Global Change. The five forces are People, Earth, Innovation, Markets and Government.

How does ESG mesh with the Five Forces? And where might anyone planning to invest responsibly search for opportunities of the kind the Five Forces are likely to generate?

Says Quinlan: “ESG investors often seek companies that promote the efficient use of resources, especially water and energy, or are reducing their carbon footprint. That certainly fits well with the Earth category in the Five Forces. As for the Innovation category, we’ve found that innovative companies are likely to be ahead of the curve in terms of key ESG themes. In the People category, there are companies that focus on demographics and diversity as key human rights issues.”

As the Five Forces continue to change the world, in ways both large and small, Quinlan says, “we believe that companies able to adapt, by becoming more efficient or more diverse or by reducing waste, stand to perform well over the long term.”

Next steps in ESG investing

If you’re interested in finding out more about investing with a focus on ESG practices, including how it might align with your personal values or whether it might be appropriate for your overall investment portfolio, be sure to talk with your investment advisor. To read about four specific investment approaches that are available on the U.S. Trust platform, see the ESG Strategies sections throughout this article.

 

1 Between September 2007 and August 2014, MSCI World ESG Index rose 130.40% and MSCI World Index rose 129.41%. MSCI, August 31, 2014

2 Sustainable and Responsible Investing Trends in the United States, US SIF Foundation, 2012. (Latest available data.)

3 Between September 2007 and August 2014, MSCI World ESG Index rose 130.40% and MSCI World Index rose 129.41%. MSCI, August 31, 2014

4 Profits with Purpose: How Organizing for Sustainability Can Benefit the Bottom Line, McKinsey & Company, July 2014.

5 Sustainable and Responsible Investing Trends in the United States, US SIF Foundation, 2012. (Latest available data.)

6 Sustainable and Responsible Investing Trends in the United States, US SIF Foundation, 2012. (Latest available data.)

7 Signatories to the Principles for Responsible Investment, UN PRI, 2013.

8 2014 U.S. Trust Insights on Wealth and Worth®, ustrust.com/survey.

IMPORTANT INFORMATION

Investing involves risk. There is always the potential of losing money when you invest in securities.

Some of the featured participants are not employees of U.S. Trust. The opinions and conclusions expressed are not necessarily those of U.S. Trust or its personnel. Any of their discussions concerning investments should not be considered a solicitation or recommendation by U.S. Trust and may not be profitable.

Projections made may not come to pass due to market conditions and fluctuations.

Past performance is no guarantee of future results.

Always consult with your independent attorney, tax advisor, investment manager and insurance agent for final recommendations and before changing or implementing any financial, tax or estate planning strategy.

OTHER IMPORTANT INFORMATION

Equities
Equity securities are subject to stock market fluctuations that occur in response to economic and business developments.

Stocks of small and mid cap companies pose special risks, including possible illiquidity and greater price volatility, than stocks of larger, more established companies.

Fixed Income
Investing in fixed-income securities may involve certain risks, including the credit quality of individual issuers, possible prepayments, market or economic developments, and yields and share price fluctuations due to changes in interest rates. When interest rates go up, bond prices generally drop, and vice versa.

There may be less information available on the financial condition of issuers of municipal securities than for public corporations. The market for municipal bonds may be less liquid than for taxable bonds. Tax-exempt investing offers current tax-exempt income, but it also involves special risks. Income from investing in municipal bonds is generally exempt from federal and state taxes for residents of the issuing state. Interest income from certain tax-exempt bonds may be subject to certain state and local taxes and, if applicable, the alternative minimum tax (AMT).

International Investing
International investing involves special risks, including foreign taxation, currency risks, risks associated with possible differences in financial standards, and other risks associated with future political and economic developments. Investing in emerging markets may involve greater risks than investing in more developed countries. In addition, concentration of investments in a single region may result in greater volatility.

Commodities
Trading in commodities, such as gold, is speculative and can be extremely volatile. There are special risks associated with an investment in commodities, including market price fluctuations, regulatory changes, interest-rate changes, credit risk, economic changes and the impact of adverse political or financial factors. Tangible assets can fluctuate with supply and demand, such as commodities, which are liquid investments, unlike most other tangible investments.

Energy and natural resources stocks have been volatile. They may be affected by rising interest rates and inflation, and can also be affected by factors such as natural events (for example, earthquakes or fires) and international politics.

Alternative Investments
Alternative investments are intended for qualified and suitable investors only. Alternative investments are speculative and involve a high degree of risk. Alternative investments such as derivatives, hedge funds, private equity funds and funds of funds can result in higher return potential but also higher loss potential. Changes in economic conditions or other circumstances may adversely affect your investments. Before you invest in alternative investments, you should consider your overall financial situation, how much money you have to invest, your need for liquidity and your tolerance for risk.

Real Estate Investment Trusts (”REITs”) involve a significant degree of risk and should be regarded as speculative. They are only made available to qualified investors under the terms of a private offering memorandum. Holdings in a REIT may be highly leveraged and, therefore, more sensitive to adverse business or financial developments. REITs are long term and unlikely to produce a realized return for investors for a number of years. Investments in real estate securities can be subject to fluctuations in the value of the underlying properties, the effect of economic conditions on real estate values, changes in interest rates and risks related to renting properties, such as rental defaults.

Technology stocks may be more volatile than stocks in other sectors.

The 2014 U.S. Trust Insights on Wealth and Worth® survey is based on a nationwide survey of 680 high-net-worth and ultra-high-net-worth adults with at least $3 million in investable assets, not including the value of their primary residence. Respondents were equally divided among those who have between $3 million and $5 million, $5 million and $10 million, and $10 million or more in investable assets. The survey was conducted online by the independent research firm Phoenix Marketing International in February and March of 2014. Asset information was self-reported by the respondent. Verification for respondent qualification occurred at the panel company, using algorithms in place to ensure consistency of information provided, and was confirmed with questions from the survey itself. All data have been tested for statistical significance at the 95% confidence level.

The MSCI KLD 400 Social Index sources the MSCI USA IMI ESG Index, which is made up of securities of large, mid and small cap U.S. companies selected using an ESG best-in-class methodology. Companies involved in the following activities are excluded from the selection universe: alcohol, gambling, tobacco, military weapons, civilian firearms, nuclear power, adult entertainment and genetically modified organisms (GMOs). The MSCI KLD 400 Social Index is designed to maintain similar sector weights as the MSCI USA Index and targets a minimum count of 200 large and mid cap constituents. The MSCI USA Index is a free-floating adjusted market capitalization index that is designed to measure large and mid cap U.S. equity market performance. The MSCI USA Index is member of the MSCI Global Equity Indices and represents the U.S. equity portion of the global benchmark MSCI ACWI Index. The MSCI World ESG Index is a capitalization weighted index that provides exposure to companies with high environmental, social and governance (ESG) performance relative to their sector peers. MSCI World ESG consists of large and mid cap companies in 23 Developed Markets (DM) countries. The index is designed for investors seeking a benchmark comprised of companies with strong sustainability profiles and relatively low tracking error to the underlying equity market. The MSCI World Index captures large and mid cap representation across 23 Developed Markets (DM) countries. With 1,615 constituents, the index covers approximately 85% of the free float–adjusted market capitalization in each country.