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ESG Today: Embraced, Shunned And Growing

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Morningstar’s Jon Hale shares his perspective on environmental, social and governance (ESG) investing – also called sustainable investing -- and why he believe it is here to stay.

As sustainable investing continues to affirm its place among traditional strategies, it is still a contested, sometimes polarizing, concept. Jon Hale, Director of ESG Strategy at Morningstar, recently joined The Flexible Advisor podcast to discuss ESG as part of the larger picture, some common concerns, and what will make sustainability a new standard.

“This is where people are”

Public awareness around environmental, social and governance issues has become increasingly commonplace. As Hale notes, “This is just where people are. People as workers and as consumers are holding businesses to higher standards. Why wouldn't people as investors do the same? When somebody buys a consumer good, sustainability is not the primary reason. They buy the good because it offers a utilitarian benefit. But, with all things being equal, they’re saying ‘I want to buy the more sustainable version of this’. I think the same holds for sustainable investing. ‘I want an investment that's going to help me reach my financial goals, but I'd like the more sustainable version, please’”.

KEY TAKEAWAYS

  • Public companies of every size are becoming attuned to and aligned with ESG concerns. 
  • Sustainable funds have provided competitive performance over time. 
  • ESG investment screens are becoming more commonplace. 

Yes, companies are taking note


Sustainable investing challenges the established role of investors in corporate governance. Aren’t these issues better left to regulators and politicians? Hale doesn’t see it as an either/or proposition: “Issues like diversity, equity, and inclusion (DEI), not to mention climate change, are not necessarily only to be addressed through the political system. When consumers tell a company, ‘We're not buying this product because you're a polluter’, or for whatever reason, it can be just as effective as a regulation. When investors say ‘as we invest, we want to do it sustainably’ there's an impact. Five years ago, when we started emphasizing ESG at Morningstar, I had to explain to a lot of companies what ESG even stood for. Today, public companies of every shape and size understand ESG, take it seriously and, for the most part, see it as something that will be embedded in the way they do business going forward”.

When investors say ‘as we invest, we want to do it sustainably’ there's an impact.
--Jon Hale, Director of ESG Strategy, Morningstar

Performance anxiety


Many advisors assume that sustainable investing entails a trade-off in returns. Morningstar research helps dispel that concern. “The facts have been for a long time that sustainable funds, on the whole, perform just as well as any other type of funds,” says Hale. “Our recent sustainable funds landscape report found that of all the sustainable funds in the US universal, 54% outperformed their category last year. On average, about 50% outperform a category average. For the trailing three- and five-year periods, about 75% of sustainable funds in the US outperformed their category peers. There's a lot of evidence in this report that sustainable funds can perform at least as well as conventional funds.

The path forward

Given its sharp rise from niche to notoriety, some advisors dismiss ESG as a passing fad. We asked Hale how he sees the role of sustainability as an investment theme over the long term. “ESG is becoming firmly embedded within virtually every asset manager, at least as part of what they do,” he said. “That doesn't mean they’re all going to offer only sustainable investments, or only funds with an intentionally central focus on sustainability. But we’re going to see more and more conventional investments integrating an ESG component when evaluating companies.

  • Do they have ESG-related risks that we need to understand?
  • When voting on proxies are there things that we are going to express?

I think we’re definitely going to see that infused throughout the investment world. Even if you're not particularly interested in intentionally sustainable investments, it's going to be there at some basic level.”

Another driver of ESG adoption, in Hale’s view: The intergenerational transfer of wealth. “We consistently find that younger investors, also female investors are generally more interested in sustainable investing. So as wealth transfers to these emerging investors, that's going to be their interest. The same is true with advisors really get the new generation of investors. I think they are going to drive it too.”

 

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Please remember that all investments carry some level of risk, including the potential loss of principal invested. They do not typically grow at an even rate of return and may experience negative growth. As with any type of portfolio structuring, attempting to reduce risk and increase return could, at certain times, unintentionally reduce returns. An ESG investment methodology that includes and excludes issuers and assigns weights to issuers by applying non-financial factors, such as ESG factors, such ESG investment methodology may underperform the broader equity market or other investment products that do or do not use ESG investment criteria. An ESG investment methodology will influence exposure to certain companies and sectors.

Currently, there is a lack of common industry standards relating to the development and application of ESG criteria, which may make it difficult to compare an ESG investment methodology with the investment strategies of other investment products or funds that integrate certain ESG criteria. The subjective value that investors may assign to certain types of ESG characteristics may differ substantially from that of an ESG investment methodology or a data provider.

Not all FlexShares ETFs have an ESG focus. For more information on which FlexShares ETFs have an ESG focus, please visit flexshares.com

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