Companies and fund managers are responding to investor demand for them to behave more responsibly but the Securities and Exchange Commission wants the proof from funds.
The SEC sent a letter to fund managers last year asking for their methods in evaluating companies and what companies they ultimately invest in.
ESG funds took in $20.6 billion in new money in 2019, well above the $5.5 billion the previous year, according to Morningstar. That brings total assets to $137.3 billion. And although that is a respectable pile of money, it is still a sliver of the $20.7 trillion held by mutual and exchange-traded funds.
The segment is attracting star attention from firms such as BlackRock, whose CEO, Larry Fink, proclaimed that sustainability is the company’s new standard for investing.
“As an asset manager, BlackRock invests on behalf of others, and I am writing to you as an advisor and fiduciary to these clients,” Fink wrote in a letter to CEOs last week. “And we have a deep responsibility to these institutions and individuals – who are shareholders in your company and thousands of others – to promote long-term value.”
Although the term “climate change” triggers an angry reaction in some quarters, Fink said it has an impact not only on the environment but also on company performance.
“Climate change has become a defining factor in companies’ long-term prospects,” Fink wrote. “Last September, when millions of people took to the streets to demand action on climate change, many of them emphasized the significant and lasting impact that it will have on economic growth and prosperity – a risk that markets to date have been slower to reflect. But awareness is rapidly changing, and I believe we are on the edge of a fundamental reshaping of finance. [Text bolded by BlackRock.]”
In a letter to clients, Fink said the firm will be offering a sustainable version of its funds, doubling the number of ESG ETFs. But he went further and said that active investment managers will also change their approach.
“By the end of 2020,” Fink wrote, “all active portfolios and advisory strategies will be fully ESG integrated – meaning that, at the portfolio level, our portfolio managers will be accountable for appropriately managing exposure to ESG risks and documenting how those considerations have affected investment decisions.”
Stakeholders Replace Shareholders
Fink’s letter might be seen as a sign of a greater shift in corporate governance. Another seismic event was the recasting of the very purpose of corporations by the Business Roundtable in August.
The roundtable, which comprises the leaders of the nation’s top companies, shifted the purpose of a corporation from purely a shareholder benefit to a stakeholder benefit. Included in stakeholders are “customers, employees, suppliers, communities and shareholders,” according to a letter signed by 181 CEOs.
Jamie Dimon, JP Morgan CEO, put the issue in stark terms in a statement released by the roundtable.
“The American dream is alive, but fraying,” Dimon said. “Major employers are investing in their workers and communities because they know it is the only way to be successful over the long term. These modernized principles reflect the business community’s unwavering commitment to continue to push for an economy that serves all Americans. [Text bolded by the roundtable.]”
Besides any philosophical or political opposition that investment managers might have about ESG, they and other investors were surely turned off by the funds’ performance, which tended to underperform the market.
But the performance anxiety might be fading, according to Barron’s.
“Barron’s fourth annual ranking of big-cap equity mutual funds that received an ‘above average’ or ‘high’ sustainability rating from Morningstar shows that they outperformed comparable funds with lower sustainability ratings,” Barron’s reported last week. “The 189 actively managed funds that met those criteria returned 30% in 2019, just shy of the 31.5% that the S&P 500 index returned for the year.”
SEC Asks For Data
The movement’s growth has earned the scrutiny of the SEC, which issued a request for investment managers to describe how they identify a company as ESG and gauge its performance. The commission also asked for a list of companies the managers invest in.
SEC Commissioner Hester Peirce is particularly critical of ESG funds and the people who say they assess ESG performance. Peirce, who was appointed by President Donald Trump, spoke about ESG in a June speech to the American Enterprise Institute, a conservative-leaning think tank.
“We see labeling based on incomplete information, public shaming and shunning wrapped in moral rhetoric preached with cold-hearted, self-righteous oblivion to the consequences, which ultimately fall on real people,” Peirce said. “In our purportedly enlightened era, we pin scarlet letters on allegedly offending corporations without bothering much about facts and circumstances and seemingly without caring about the unwarranted harm such labeling can engender. After all, naming and shaming corporate villains is fun, trendy, and profitable.”
Peirce said the environmental, social and governance coverage stretched credibility.
“E, S, and G tend to travel in a pack these days, which makes it hard to establish reliable metrics for affixing scarlet letters,” she said. “Governance at least offers some concrete markers, such as whether there are different share classes with different voting rights, the ease of proxy access, or whether the CEO and Chairman of the Board roles are held by two people. Even with these examples, however, people do not agree on which way they cut, and they may not cut the same way at every company.”
The environmental and social categories tend to be much more nebulous, Peirce said.
“The environmental category can include, for example, water usage, carbon footprint, emissions, what industry the company is in, and the quantity of packing materials the company uses, she said. “The social category can include how well a company treats its workers, what a company’s diversity policy looks like, its customer privacy practices, whether there is community opposition to any of its operations, and whether the company sells guns or tobacco. Not only is it difficult to define what should be included in ESG, but, once you do, it is difficult to figure out how to measure success or failure.”
Another concern is the impact on companies trying to provide information to analysts. Peirce cited the experience of the insurance carrier, Travelers, in trying to fulfill the requests.
“Some scorecard producers attempt to get information from the companies directly by submitting surveys to companies, the responses to which are then used to rate the ESG risk of the companies surveyed,” Peirce said. “A senior counsel from a major insurance company reported her experience at a recent Investor Advisory Committee meeting at the SEC. Her company received approximately 55 survey and data verification requests from ESG rating organizations in the last year. By her company’s estimate, it took 30 employees and 44.8 work days to respond to just one of these surveys. While this is just one company’s experience with one survey, one could expect that some surveys will go unanswered because of lack of corporate resources.”
Steven A. Morelli is editor-in-chief for AdvisorNews. He has more than 25 years of experience as a reporter and editor for newspapers and magazines. He was also vice president of communications for an insurance agents’ association. Steve can be reached at firstname.lastname@example.org.
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