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The magazine of independent research for the world’s financial professionals December/January 2016 Sustainable Investing Takes Off A new generation of investors wants strategies that deliver performance and peace of mind.
Rights and Responsi- products, for these vehicles. In embracing
the corporate structure, the act defines investors
even a single business is engaged. The research
for a diversified portfolio of investments can
bilities We should as owners and gives them advocates in the
form of a predominantly independent board of
be daunting. Fortunately, the market increasingly
offers assistance, as firms are stepping up
be encouraging ESG, directors to represent their interests to the
management company that is employed to run
to provide insights into the practices of different
businesses. Morningstar will soon aggregate
not mocking it. the fund. That view is utterly different from the insights of one such firm, Sustainalytics, to
the product view of funds where manufacturers offer fund investors insights into the ESG footprint
make product, which is sold through distribution of the funds they consider for their portfolios.
channels to consumers. Owners have rights; To me, this transparency is wholly in keeping with
PHILLIPS CURVE consumers are prey, hence the phrase “buyer the rights due to those individuals responsible
Don Phillips beware.” Those that treat investors as owners enough to live within their means and save and
bestow upon them the respect due to those invest for the future.
who accept the responsibility of planning for
Environmental, social, and governance, or tomorrow rather than just living for today. ESG is a great and powerful movement,
ESG, concerns are often presented as liberal forces not because it rights some wrong inherent
combating the evils of Big Business to somehow Chief among these rights that those responsible in business, but because it removes obstacles that
make the ugly activity of investing more palatable individuals who become investors are due keep people from investing. It’s far too easy
to good-hearted individuals. This view has is transparency and choice about how their money an excuse to not save for tomorrow because you
been strengthened by right-wing opponents of is invested. They have a right to know who think investing supports causes you dislike.
ESG, such as a noted U.S. business periodical that is running the businesses they invest in, what ESG research empowers investors to make more
has long derided ESG investing approaches, practices they deploy in managing those informed choices, to better align their money
claiming that investors should invest for maximum
gain and if they feel guilty about how those gains
were won to simply make a charitable donation
out of some of their winnings to ease their ESG is a great and powerful movement, not
conscience. To me, this explanation of ESG gets
it dead wrong, being founded on false premises, because it rights some wrong inherent
most notably that investing is a somehow
tainted activity that needs to be cleaned up. in business, but because it removes obstacles
I believe that investing itself is a socially conscious
that keep people from investing.
act. It means deferring gratification today for
greater security and opportunity for yourself and
your loved ones tomorrow. It is, quite simply,
what a responsible adult does. Those who can
invest and don’t do so, such as Vice President Joe
Biden, who boasts (falsely) of owning no stock
or bonds, are in my eyes irresponsible and businesses, and what consequences those with their values, which is their right to do. It
poor role models. Conversely, those who step up activities have on the world in which they operate. gives investors a louder voice to corporate leaders.
and embrace the responsibility of becoming Investors have the absolute right to choose Over time, the practice, which today is in its
investors deserve our respect and should which activities they are comfortable embracing infancy, will evolve and become more sophisti-
be entitled to fundamental rights as responsible and which they desire to avoid. They do not cated. In the process, it will lead to better behavior
citizens. Our society benefits from having more have to buy every stock in the market just because and increased accountability. But already it is
investors, not fewer. some academic believes buying the whole market a powerful force that appropriately reflects investor
is the sainted way to invest. They can—and rights. And that is a very responsible thing. K
The Investment Company Act of 1940, the should—direct their hard-earned money in the
legislation on which the U.S. fund business is ways that they choose. Don Phillips is a managing director with Morningstar. He is
a member of the editorial board of Morningstar magazine.
based, embraces this notion of investors’
rights, choosing a corporate organization of Of course, that’s not always an easy task. It takes
investment companies, rather than investment great effort to uncover all the activities in which
global.morningstar.com/Morningstarmagazine 1
Spotlight
ESG ESG Thrives in Europe
Sustaining Success
42
44
The Appeal of
Sustainable Investing
Amid a demographic
shift, more investors want
to have an impact.
SUSTAINABLE INVESTING Grantham’s obsessions reflect widespread
Jon Hale concerns of investors over sustainability issues,
as well as the growing recognition of the
need to move toward a more sustainable global
Sustainability is on a lot of people’s minds these economy. In areas such as consumer choice
days. Jeremy Grantham opened his keynote and workplace satisfaction, surveys report
address at last summer’s Morningstar Investment widespread support for sustainability concepts.
Conference by outlining several issues that he According to the 2014 Nielsen Global Survey
said were “obsessing” him, among them long-term of Corporate Social Responsibility, more
resource limitations, climate problems, than half of consumers surveyed globally said
food problems, income inequality, and the loss they would be willing to pay more for products
of corporate stakeholders. and services from companies committed
global.morningstar.com/Morningstarmagazine 3Spotlight: ESG
EXHIBIT 1
The ESG Landscape Assets in sustainable investments are growing in the to positive social and environmental impact.1 Two
United States. thirds said they would prefer to work for a socially
responsible company.
(USD Billions)
Similarly, interest in sustainable investing
7,000
appears to be growing in the investment world,
6,000 particularly among women and younger
people, two groups who are rapidly becoming
5,000
more influential investment decision-makers.
4,000 Recent studies by U.S. Trust 2 and Morgan Stanley 3
3,000 found a large majority of female investors,
more than 70% in each study, agreed that
2,000 environmental, social, and governance, or ESG,
1,000 factors are important considerations when
making an investment, while men were more
1995 1997 1999 2001 2003 2005 2007 2010 2012 2014 0
evenly divided. A 2011 Pew Research survey found
Source: US SIF, The Forum for Sustainable and Responsible Investing. Gen-Xers and, especially, millennials to be
more concerned about environmental issues and
global warming than baby boomers.4 The Morgan
EXHIBIT 2 Stanley survey found that 84% of millennial
Jumping on the Bandwagon Nearly 1,400 asset-management firms, representing investors were interested in sustainable investing
$60 trillion in assets under management, have signed the U.N. Principles and were twice as likely as investors overall to
make sustainable investment decisions.
for Responsible Investment.
Women and millennials are becoming more
Assets under management (USD trillion) Number of Signatories
influential investment decision-makers.
70 1,400 1400
In the United States alone, women now have
decision-making control over an estimated 40%
60 1,200 1200
of the nation’s investable assets.5 By some
estimates, $30 trillion is going to pass from baby
50 1,000 1000
boomers to younger generations over the next
half century.6 That money will move into the hands
40 800 800
of investors who appear to be significantly
more interested in sustainable investing than
30 600 600
their elders.
20 400 400
A Growth Industry
With these favorable demographic trends just
10 200 200
starting to provide a tailwind, sustainable investing
has already seen a significant increase in
0 04/ 04/ 04/ 04/ 04/ 04/ 04/ 04/ 04/ 04/ 0 0
assets under management ( EXHIBIT 1 ). In its 2014
biennial report on assets under management,
2006 2007 2008 2009 2010 2011 2012 2013 2014 2015
US SIF, The Forum for Sustainable and Responsible
Source: U.N. Principles for Responsible Investment. Investment, identified $6.6 trillion invested in the
1 “Doing Well by Doing Good: Increasingly, Consumers Care About Social Responsibility, but Does Concern Convert to Consumption?” June 2014. The Nielsen Co.
2 “2015 U.S. Trust Insights on Wealth and Worth.” 2015. U.S. Trust.
3 “Sustainable Signals: The Individual Investor Perspective.” February 2015. Morgan Stanley Institute for Sustainable Investing.
4 “The Generation Gap and the 2012 Election.” Nov. 3, 2011. Section 8: Domestic and Foreign Policy Views. Pew Research Center.
5 “Power of Purse Highlights Women’s Wealth Leadership.” Jan. 23, 2015. Morgan Stanley.
6 “The ‘Greater’ Wealth Transfer: Capitalizing on the Intergenerational Shift in Wealth.” 2015. Accenture.
4 Morningstar December/January 2016field in the United States, a 76% increase from to incorporate ESG factors into their investment Definitional
its 2012 study. That’s a big number, and it includes analysis and decision-making process, to be active What exactly is meant by sustainable investing?
a wide range of approaches, some more owners engaging with companies about ESG There are not only varying definitions and
comprehensive in their approach to sustainability issues, and to report publicly on their activities and approaches, but investors have often been able to
than others, among mostly institutional investors. progress. Nearly a decade later, the number define it for themselves and then have asset
The same study showed a much smaller, of signatories is nearing 1,400, and assets under managers customize portfolios to suit. This can
yet growing, retail segment with just less than management are nearly $60 trillion ( EXHIB IT 2 ). work in the institutional and high-net-worth space,
$2 trillion invested in various open-end, Signatories include many large institutional but raises the challenge of scalability in retail
variable-annuity, exchange-traded, and closed-end investors, investment managers, and investment investing, where asset managers have to offer
funds. The size of that segment, however, more service providers. Among the more than standardized, rather than customized, portfolios.
than tripled between 2012 and 2014.7 900 investment managers are 11 of the 15 largest That means the conventional asset managers
in the world, including BlackRock, Vanguard, wanting to get into the game will have to decide
Asset-management firms are showing more JPMorgan, Goldman Sachs, PIMCO, and how to define sustainability.
interest in sustainable investing. In April 2006, Franklin Templeton.
the United Nations-supported Principles Overcoming the definitional challenge requires
for Responsible Investment, or PRI, was launched Challenges Remain sustainable investing to be defined in a reasonable,
with 100 signatories, representing $6.5 trillion As it moves toward the investing mainstream, easily understood way that reduces the
in assets under management, committing sustainable investing faces several challenges. confusion that can derail a conversation from
7 “Report on US Sustainable, Responsible and Impact Investing Trends.” 2014. The Forum for Sustainable and Responsible Investing.
What’s in a Name?
While we refer to sustainable investing as an approach nuclear-power producers. The first retail SRI mutual part of the broader anti-apartheid movement, but
that incorporates environmental, social, and gover- funds used a similar approach. progress is more typically made in a lower-profile way
nance, or ESG, factors in an investment process, there through discussions with company management.
are a number of other terms commonly used to Still in widespread use today, exclusionary screening
describe the field: socially conscious (a term still used is more investor-centric than outcome-oriented. As more investors focused on engagement issues, these
in Morningstar’s database), socially responsible, It is also relatively easy for asset managers to use concerns increasingly found their way into evaluations
ethical, green, and impact. The US SIF industry group to address the needs of institutional and high-net-worth of companies that, in turn, began to be used as part
calls itself “The Forum for Sustainable and Responsible investors who want customized portfolios that align of the security-selection process. Rather than excluding
Investment.” An annual industry meeting is with their values. An asset manager can adapt many companies based on objectionable product involvement
called “The Conference on Sustainable, Responsible, of its existing strategies by simply excluding companies in a traditional SRI portfolio, investors expanded
Impact Investing.” based on a client’s list of concerns and re-optimizing their focus on how well companies were addressing the
the portfolio. While this approach raised concerns that range of environmental, social, and governance
Investors have engaged these kinds of issues since the exclusionary screening would lead to inferior issues that had often been the subject of corporate
1970s, when many faith-based institutions, colleges investment results, those concerns have proved engagements, and these factors were increasingly seen
and universities, and foundations began to better align to be largely unfounded. as material to a firm’s financial success.
their investments with their missions. Commonly
known as socially responsible investing, or SRI, this Many 20th century SRI investors did not simply have What we are calling sustainable investing encompasses
approach was largely concerned with screening screened portfolios. As active owners, they also these broader ESG concerns in portfolios and while
out certain types of products or services that were engaged companies on broader issues of corporate many traditional SRI-screened portfolios still exist,
inconsistent with the values of the investor. Tobacco, social and environmental responsibility through proxy the field overall has become increasingly focused on
alcohol, and gambling were common exclusions voting, filing shareholder resolutions, and importantly, the more comprehensive ESG approach.
from the portfolios of certain religious organizations, direct engagement with management. Perhaps
for example. Investors also frequently excluded firearms the most notable instance of active engagement Jon Hale
and military weapons manufacturers, and reflecting occurred in the 1980s when investors pressured
one of the key environmental concerns of the day, companies to stop doing business in South Africa as
5Spotlight: ESG
EXHIBIT 3
the onset and helps advisors and consultants move Different Interests A high percentage of millennials and women say they are
their conversations with clients forward. interested in ESG investing. Financial advisors? Not so much.
I propose the following basic definition: p Investors p Advisors Interest (%)
100 100
Sustainable investing is an approach that takes
90
into account environmental, social, and
governance factors and their80impact throughout 80
the investment process. 70
60 60
Beyond that, the specifics will vary, just as they
50
do for any investment approach. Value strategies,
for example, share the basic40
goal of investing in 40
undervalued companies, but30 employ many
different approaches to do that. Some sustainable
20
investment strategies may focus on a best-in- 20
class approach by industry. 10
Others may emphasize
0 or focus on
metrics such as carbon footprint Millennials Female Overall Male Little or Somewhat Highly 0
positive product impacts. Some asset managers No Interest Interested Interested
may be active owners who publish proxy voting
Sources: Morgan Stanley Institute for Sustainable Investing, Cerulli Associates.
guidelines, pursue shareholder resolutions,
and engage directly with companies on ESG issues.
Regardless of the specifics, when the would- analysis. If anything, the weight of existing At the portfolio level, there is even less information
be sustainable investor walks through an research suggests that there is not a performance on how the holdings in a fund stack up on various
advisor’s door, most often with only an inchoate penalty for sustainable investing and that there sustainability criteria. This is the main reason
notion of what sustainable investing actually may be a performance advantage. why Morningstar is working on portfolio sustain-
means in practice, the above definition provides ability scores using data from Sustainalytics.
a common basis to move forward. In the final analysis, there are so many possible (See our interview with Sustainalytics’ CEO
ways to address sustainability in the investment Michael Jantzi on Page 44.) These scores, due
Performance context that performance ultimately comes out in 2016, will give advisors and investors
Performance is a perennial challenge. What down to execution. Some managers will be better the ability to compare funds based on how well
should be the performance expectations at it than others, pure and simple. their holdings are handling ESG risks and
of sustainable investors? There are theoretical opportunities. They will allow investors to compare
reasons why sustainable investing might be Information conventional funds with self-identified sustainable
expected to underperform conventional investing. Before sustainable investing can enter the funds, as well as to choose funds based on
Limiting one’s investable universe for nonfinancial mainstream, information and analysis of sustain- whatever level of sustainability score they desire.
reasons can result in outperforming stocks able investments have to become more readily The portfolio sustainability scores will help
being left out of a portfolio and, in any event, accessible to advisors and investors. We’ve seen advisors and plan consultants evaluate funds
tracking error relative to benchmarks. There large firms such as Merrill Lynch, Morgan as well as client portfolios and plan lineups.
is also the argument that stocks that are shunned Stanley, and UBS starting to rectify this problem
by investors for whatever reason exact a premium by creating sustainable-investing platforms Supply and Demand
and, therefore, are expected to outperform. for their advisors. Despite the widespread and growing interest
in sustainable investing, the supply of viable
In practice, however, there is little evidence While firms like Sustainalytics are in the business strategies in the retail space is relatively limited.
indicating a performance penalty for sustainable of providing company-level ESG ratings and Even among the institutional and high-net-
investing, particularly among mutual funds. analysis, their information flows primarily to asset worth investors who dominate the space today,
It is also possible that sustainable investing can managers to assist them with incorporating ESG options are lacking for truly integrated ESG
lead to outperformance because the consideration factors in their strategies. Very little of this strategies and for targeted high-impact
of ESG issues can point analysts to material company-level ESG information reaches advisors investments in areas such as private equity and
issues that may not surface in traditional financial or everyday investors. infrastructure. The number of retail mutual
6 Morningstar December/January 2016funds tagged in Morningstar databases as
socially responsive stands at 175 in the United
States and 1,797 globally. Many of these ESG Strategies Perform Well
funds are older, more-traditional SRI funds that
use exclusionary screening. Not surprisingly,
More and more academic and industry studies A Morgan Stanley study of U.S.-based mutual
there have been a number of new fund launches are demonstrating that sustainable investing funds and separately managed accounts,
in the space in 2015. does not underperform conventional investing, and using Morningstar data, concluded that sustain-
there is mounting evidence that incorporating able investments usually met and often
Despite these recent gains, however, it remains environmental, social, and governance factors can exceeded the performance of comparable
difficult for practitioners to put together have a positive impact on performance. traditional investments on both an absolute and
client portfolios that include sustainable options risk-adjusted basis.2
in all parts of the asset allocation. It is also In 2014, researchers at Oxford analyzed nearly
200 studies, reports, and articles on sustainability As of September, there were 1,797 funds
hard for fiduciaries to recommend sustainable
and found that at the firm level:1 in Morningstar’s database tagged as “socially
investment options that don’t have sufficient—
conscious.” Using the Morningstar Rating
and successful—track records. Perhaps these g90% of the studies on the cost of capital show for funds as a measure of risk-adjusted return
challenges help explain the lack of interest in ESG that sound sustainability standards lower the cost relative to investment category, we see in
of financial advisors ( E X HI BI T 3 ). of capital of companies. the chart below that socially conscious funds have
g88% of the research shows that solid ESG practices a positive tilt relative to the overall universe
As a result of these difficulties, client demand may result in better operational performance of firms. of funds.
not be met with a portfolio entirely consisting g80% of the studies show that stock price
of sustainable investment options. In those cases, performance of companies is positively influenced Jon Hale
by good sustainability practices.
the Morningstar sustainability scores will help
meet the demand by allowing investors to evaluate
conventional funds’ portfolios on the basis
of sustainability criteria and plugging them in p All Morningstar Rated Funds p Socially Conscious Funds (%)
alongside more-intentional sustainable strategies
50
to form a sustainable portfolio for the client.
Jury Is Still Out
These challenges, in the end, are not insurmount- 40
able, but they show that while sustainable
investing may be poised to enter the mainstream,
its success is not guaranteed. At the same
30
time, given the demographic trends favoring
sustainable investing, investment professionals
today have strong incentive to meet that
demand as they transition their book to be younger 20
and more female-oriented. Sustainable investing
offers advisors a way to add value not just in terms
of performance but in terms of aligning client 10
portfolios with a desire to support the transition
to a sustainable global economy. This, in turn,
ties investors more closely to their investments,
making it more likely that they will stay the course Q QQ QQQ QQQQ QQQQQ 0
for the long run. K Source: Morningstar. Data as of 09/30/2015.
Jon Hale, CFA, Ph.D., is Morningstar’s director of manager
research, North America. He is a member of the editorial
board of Morningstar magazine.
1 Clark, Gordon, Andreas Feiner, and Michael Viehs. 2014.“How Sustainability Can Drive Financial Outperformance.”
2 “Sustainable Reality: Understand Performance of Sustainable Investment Strategies.” March 2015. Morgan Stanley
Institute for Sustainable Investing.
7
Electricity Consumption Forecast in 2020 (TWh)Spotlight: ESG
ESG Thrives in Europe sible Investment, have included the UN Global
Compact principles in their investment
Continent’s institutional investors lead
processes, and have developed a policy regarding
controversial weapons.
way in making offerings sustainable. Of course, Europe is not a homogeneous market.
Some notable differences and variations
in ESG practices can be spotted between different
European countries. According to Eurosif, the
pan-European sustainable and responsible
investment membership organization, the French
ESG pension funds in the world. Already perceived ESG market is traditionally defined by combining
San Lie in the market as one of the front-runners in “best-in-class” and “sustainability-themed”
sustainable investing, ABP announced in October strategies. In the United Kingdom, the most
a radical change to its investment policy. practiced strategy is “engagement and voting.”
Europe has a large head start over the United In response to members, ABP said it will target In the Netherlands, “exclusions” is the most
States in ESG investing ( E X H I BI T 1 ). According sustainable and socially responsible investments. popular strategy, followed by “norms-based
to the 2014 Global Sustainable Investment It also now has a number of concrete objectives, screening” and engagement and voting. The latest
Review, 58.8% of European invested assets already including cutting 25% of carbon-dioxide- trend in most European markets is growth
are invested in a sustainable way, compared related investments from its equity portfolio by of “impact investing” vehicles.
to 31.3% in Canada and 17.9% in the United States 2020. Also, investments that contribute to a better
( E X H I B I T 2 ). and cleaner future are to be doubled from EUR European governments play a large role, too.
29 billion to EUR 58 billion by 2020. In France, public authorities are creating
One of the reasons Europe is leading the way an SRI label for funds applying ESG criteria. In the
is the fact that European institutional investors see Private banks and wealth managers are also Netherlands, the government published the
sustainable investing as part of their fiduciary in the process of making their offerings more Pension Governance Code in September 2013.
responsibility. A recent example is the Dutch civil sustainable. Rabobank, for example, decided years It gives guidance to pension funds on ESG themes
service pension fund, ABP, which has about ago to limit its offerings to funds that have such as transparency, accountability and
EUR 350 billion in assets and is one of the largest signed the United Nations Principles for Respon- communication, financial control, diversity, and
good governance. The code also requires pension
funds to define a “responsible investment”
EXHIBIT 1 EXHIBIT 2
strategy and make it available for stakeholders.
ESG Assets by Region Europe has Growth in All Regions The proportion
What the United States and European countries
twice as many assets in sustainable of professionally managed assets have in common, however, is weakness in the
investments as does the United States. devoted to sustainable investments has retail ESG market. This may be due to the
The world total in 2014 was $21.4 increased to 30.2% globally. lack of clear definitions, or the view that ESG
trillion, up from $13.3 trillion in 2012. comes with a performance penalty. This perception
Proportion of Sustainable Investments Relative should change over time. Academic and industry
Region ($ Billion) to Total Managed Assets studies are demonstrating that sustainable
investing does not underperform conventional
Europe 13,608 Region 2012 (%) 2014 (%)
investing, and there is mounting evidence
United States 6,572 Europe 49.0 58.8 that incorporating ESG factors in an investment
Canada 945 Canada 20.2 31.3 process has a positive impact on performance. K
Australia/New Zealand 180 United States 11.2 17.9 San Lie is director of manager research, Benelux
Asia 53 Australia 12.5 16.6 with Morningstar’s EMEA fund research team.
Total 21,358 Asia 0.6 0.8
Source: 2014 Global Sustainable Investment Review Global 21.5 30.2
Source: 2014 Global Sustainable Investment Review
8 Morningstar December/January 2016Sustaining Success business. It made a lot of sense to me that if we
are going to influence corporate behavior, we
ESG is a win-win for companies and
could do it through capital markets and directing
capital in particular ways. And then it didn’t
take me long even 25 or 30 years ago to uncover
shareholders, Michael Jantzi says. research that was hinting at the fact that by
investing money in that way, you could generate
positive shareholder returns over the long term.
For me, it was a no-brainer. You could have your
cake and eat it, too. Why wouldn’t we look
at social and environmental issues if it could have
SUSTAINALYTICS There may be those who are considering ESG a positive impact more broadly and also
Jon Hale factors because they feel it’s a part of their for shareholders? So, that’s what drove me in
fiduciary duty in today’s complex investing world. this direction.
They’re looking at environmental and social issues
Sustainalytics has provided the global to evaluate risks and opportunities that might When you think back on the 1990s, some investors
investment community with research and analysis otherwise be missed. In other words, they’re doing were starting to think about sustainability issues,
on companies’ sustainability performance it to have a more informed investment decision but not that many companies were. Today, we
for more than 20 years. Now commonly called ESG, with the expectation that it leads to a positive see many more companies addressing sustainability.
for environmental, social, and governance, a contribution to longer-term shareholder value. Why is that? How did that all happen?
confluence of factors in the market and corporate Jantzi: You’re absolutely right that when I started
world is making this investing theme a main- There are other investors who approach sustain- in this in 1990, there were very few companies
stream approach. Beginning in 2016, Morningstar able investing through a values lens—while talking about sustainability or thinking about
will rate the portfolios of mutual funds and not necessarily committing to an investment it, and certainly not many at all that would actually
exchange-traded funds on environmental, social, mandate, these investors are considering publish reports or disclose what they were
and governance factors. Morningstar will companies that are doing a better job with regard doing in the area. I think it’s safe to say that it was
base the scores on ESG company ratings from to their environmental and social footprints and the capital markets—investors both retail
Sustainalytics. The founder and CEO of integrating these considerations into the and institutional that brought these issues to the
Sustainalytics, Michael Jantzi, has seen firsthand investment process. There are other investors that corporate agenda.
the development of ESG investing over the hold a combination of those objectives. But
past two decades. He has a deep understanding to me, sustainable investing is about the discipline They were brought to that agenda in two ways.
of its history and the roles companies and itself and the integration of those things into an In some instances, it was values-based—
investors are playing in this burgeoning investment process or philosophy. you shouldn’t be doing business in South Africa
area of the investment universe. I sat down because of the apartheid regime. But increasingly
with Jantzi in October to discuss the You’ve been at this a long time. How did this idea it became business-oriented—you need to
state of sustainable investing and what the of sustainability first occur to you as something you’d pay attention to how you are managing the risks
future holds. end up spending your career doing? that seem to be central to your business.
Jantzi: It occurred to me very early in my career.
You hear a lot of terms batted around these days In fact, in Canada, I was in the process of For a long time, it seemed that investors and other
describing sustainable investing. How does Michael writing my exams, heading down to be licensed stakeholders were dragging companies into the
Jantzi define it? by the Interior Securities Commission, and discussion. That’s changed wholeheartedly
Michael Jantzi: Sustainable investing is about where that would have led me, I don’t know. now. Boards of directors and senior management
the discipline of integrating environmental, teams are looking at sustainability in a much
social, and governance themes or indicators into But I heard a radio interview that focused on more sophisticated way now and in fact, in
an investment decision-making process. some U.S. pioneers in this space that were starting some parts of the world, are bringing investors
to look at environmental and social issues into the discussion.
There are a variety of reasons that practitioners as part of the investment process. That was like a
are going to undertake that sustainable light bulb going on for me. It brought together For example, in Asia, where we see capital markets
investment process or that integration, and they’re my personal interest in environmental and social lagging behind on sustainability issues, we see
not mutually exclusive of one another. issues with my passion for capital markets and some very strong corporate sustainability
global.morningstar.com/Morningstarmagazine 9Spotlight: ESG
reporting, especially out of Japan, that is helping shifts driving this. Especially in the retail social, and governance policies and less to
put these issues on both the government and high-net-worth market, there’s no question that do with actual performance metrics. Is that a fair
corporate agenda. with younger demographics, with women criticism? Does having these policies and procedures
becoming more focused on their financial futures, in place indicate something more than just a
We’re also seeing today corporate and capital and so on, we’ve seen a shift here. We’ve seen check the box to get a better sustainability score
markets working together to address some that plan participants and pension funds, as mentality on the part of the company?
common challenges, like excessive short-term well as individuals, are beginning to understand Jantzi: I think it’s a fair critique in some ways.
thinking in markets. For companies or investors, that the decisions they make on the investing But I think that looking at policies, programs,
the longer time frame you have, the more side are important not just from a financial and how certain environmental, social, governance
likely it is that you’ll be identifying ESG risks or standpoint, but they can have a positive impact risks are being managed is underappreciated.
opportunities that you need to take account of. on the broader world as well. These disclosures are indicative of actual practices
and resulting outcomes. Maybe the starting
point is that oftentimes a critique like that is
underpinned by a mistaken belief that traditional
It was a no-brainer. You could have your financial analysis is all science and no art. That
simply is not true either.
cake and eat it, too. Why wouldn’t we look
Generally our approach to ESG analysis and
at social and environmental issues if it could have providing insights starts with the idea
that any company faces a variety of ESG risks and
a positive impact more broadly and also opportunities. We understand these are going
to differ by industry and by sector. But what
for shareholders? are those key ESG issues that companies face?
Do the companies understand those issues?
If so, to what extent? And if there are ESG risks
Michael Jantzi there that we believe can be material to
their business, of course we need to understand
how those risks are being managed.
For us, looking at environmental management
So, it’s quite exciting how corporations have come I think another driver, though, is the understanding systems, looking at supply chain issues, looking
up the learning curve, but it’s even more that environmental issues and social issues are at what level within the company those issues
exciting to me to see how capital markets and not just values issues, that these are and can are managed, these are important indicators for
companies are working together. be material risks and opportunities for a business. us to understand not just whether the company
So, quite apart from what the market demand understands these risks, but how seriously they’re
There appear to be a number of factors in place today might be telling them, again it’s this idea that— taking them, and then it gives us an indication
that are increasing demands on asset managers wow, we’re living in a much more complex world, of how they will manage these risks if they hit the
to pay more attention to integrating ESG factors, and I am charged, as a portfolio manager, radar in a real way. If we see a gap between
namely shifting demographics to a younger generation to come to a judgment and make a decision in the exposure to these issues and what we think
of investment decision-makers who have a greater an increasingly uncertain world and that by is their ability to manage them, then yes, we think
affinity for sustainable investing. The same goes looking at ESG datasets and insights, I can make that’s something investors need to know about.
for women. Public policy in some places is also a driver. more informed decisions. There are some
What are your thoughts on this idea that sustainability very powerful forces, both from the market but Measuring performance is also a critical part
is becoming a more mainstream investment theme? also within the organizations themselves, that of the equation. There are an increasing number
Jantzi: There’s no question that the main- are heading towards that same end point, which of themes and indicators that we can quantify.
streaming of responsible investment is real, and is a mainstreaming of sustainability investing. They can be on the environmental side, so it can be
it’s probably something that you can date looking at carbon output, or intensity. It can be
back to the mid-2000s with the formation of the I’ve heard the criticism that a lot of the ESG on the human capital side of the equation, looking
U.N.-backed Principles for Responsible Investment. indicators that Sustainalytics uses in its company at key indicators like turnover, absenteeism—
I think you’ve highlighted one of the key drivers ESG ratings have more to do with companies those types of things. That quantitative side is
of the mainstreaming. We’ve seen demographic documenting and disclosing various environmental, getting more sophisticated every year. But then
10 Morningstar December/January 2016there also is the qualitative side of looking at Jantzi: There’s no one set course on how to in sustainability. You can then ask, well,
performance and controversies. We not only look become a leader, even within the same sector. why have regulations been advanced in Europe?
at the number of controversies occurring but also I’m an old-fashioned guy. I like holding a Probably because people living in a more
where they are happening within the organization, roadmap in my hand. GPS is nice, but it gives dense environment have demanded it. But the
and how often they are happening, and how you the illusion that there’s only one way reality is, from a product innovation stand-
companies are managing those controversies. to your destination. You do this, that and this, and point, from a lifecycle standpoint, from a supply
it’s very easy to follow. But when you look at chain standpoint, European companies are
So, really it’s about taking that 360-degree view a map, you understand that there are a variety of ahead of the curve. But I think that the gap
of a company and coming, at the end of the ways that you can get to your destination, between Europe and North American companies
day, to our final call on whether it’s well positioned
to manage ESG-related risks. It’s not just about
checking a box.
Sustainalytics designates the top 5% in each industry
If you’re in an industry that relies on the best
as industry leaders. What is it that companies are and the brightest, you want to make sure
doing today to make themselves sustainability leaders?
Jantzi: The first thing to understand is there’s that you’re attracting the best and the brightest
no single definition. As I’ve alluded to, companies
in different sectors and in different industries from the widest possible talent pool … and
face different challenges and have different
opportunities, so leadership varies differs by sector. providing them career development opportunities.
But generally speaking, a leader is going beyond
putting that environmental management That’s what leaders are doing. They’re integrating
system or auditing procedure in place. It’s going
beyond just being transparent and disclosing the ESG indicators we look at into their
what it’s doing on the sustainability front.
It’s taking ESG to the strategic level and saying
strategic and operational decision-making.
this is helping us uncover risks that have
the ability to blindside the business; it’s helping us
stay ahead of the curve. Michael Jantzi
But more important is the opportunity side of the
equation. Is sustainability being used to drive
business innovation or product development? Is it and there may be trade-offs along the way, and is narrowing. The fact is that American companies
being used to drive competitive differentiation, I think that’s what sustainability is about. You need are global in nature. They understand that as
whether that’s on the branding side or the human to find a way, from a corporate perspective, consumers become more attuned to these issues,
capital side. If you’re in an industry that relies that fits your culture, that fits your competitive they understand that as their supply chains or they
on the best and the brightest, you want to make positioning, that fits your broader industry themselves directly are operating in more
sure that you’re attracting the best and the plans. It’s really about integrating ESG consider- challenging parts of the world, whether that’s
brightest from the widest possible talent pool. ations into your business decision-making that from a community relations standpoint, a human
You want to know that vis-à-vis your competitors, provides you the advantages that you need rights standpoint, or an environmental standpoint,
you’re bringing people in and providing them and hopefully then helps you identify and avoid that these are issues that they have to understand
career development opportunities. That’s what potential risks down the road. and manage. So, I think American companies,
leaders are doing. They’re integrating the ESG because they are global citizens, are impacted not
indicators we look at into their strategic and What about the global picture? Are there significant just by what American government or American
operational decision-making. That’s really what regional differences over how companies address consumers are saying, but what their consumers
separates the leaders from those that are ESG issues? are saying in other parts of the world.
considering ESG factors at a more basic level. Jantzi: Broadly speaking, European companies
are ahead of North American and Asian And then when you go to Asia, there’s a misunder-
I’ve heard you use the roadmap versus GPS analogy companies. The regulatory environment in standing that sustainability issues are not on
that I thought was insightful. Europe has done a lot to spur the interest the agenda at all. That’s simply not true. In some
global.morningstar.com/Morningstarmagazine 11Spotlight: ESG
sectors, real estate for example, there’s global think about putting management structures long-term horizons that fit well with sustainability
leadership in Asia. You have some very progressive in place, even though at this point your exposure issues. On the retail side, we’ve talked about
Asian real estate companies. You have strong may be several levels below what you’re seeing demographic changes and transfers of
sustainability reporters out of Japan. for your larger-cap competitors. wealth. Individuals are looking for ways now
to align their personal financial decisions
Asia is not homogeneous. It’s a collection Let’s talk more specifically about the big question of with their values, and that’s going to continue
of different cultures and we can’t expect them whether sustainability creates shareholder value. to drive retail demand.
to adopt a European or North American model What’s the evidence for that from your perspective?
of sustainability. Asia will find its own way forward Jantzi: First of all, that’s a question that will What are the challenges going to be? We are living
on what sustainability means. I think what never be settled. I think, though, that there’s been in a world that is more and more data-rich.
they’ll do is take the best practices in Europe and a very important shift. When I started in this We have overwhelming amounts of data coming
North America and Australia and other parts business, the idea was, if you want to look at ESG at us from every direction every single second.
of the world, adapt it for their own situations, and issues as part of your investment decision, So, the challenge for the field of ESG research will
move forward accordingly. God bless. Good for you. Just as long as you be to cut through that noise—that vast amount
understand that achieving a competitive financial of information and data—to provide real insights
What about smaller companies that don’t have return is on absolutely the other end of the to our clients. That’s a challenge we’ve had
sustainability policies and practices in place because spectrum. Today, there is a much better under- for 25 years, and that’s just going to be ratcheted
they don’t have the resources or scale to do so? standing that they’re not on opposite ends up more as we move from being large-cap-
How should investors evaluate that? of the spectrum. Actually, these two themes are focused to include smaller companies, as we
Jantzi: It’s a great point and an important theme sitting side by side. In fact, increasingly, the include additional asset classes and other parts
for responsible investment going forward. mainstream understands that they’re dependent of the world.
I think the fact that we have focused on large upon one another.
caps is appropriate. They’re the companies One final question: 20 years ago, I recall a fairly
that are going to have the largest environmental Two and a half decades ago, people would say dubious attitude toward corporate ESG practices on the
and social footprint. it’s against your fiduciary duty as a portfolio part of sustainable investors. Is that mood more
manager or an investment professional to look at optimistic today?
But small caps are obviously important for the anything but the bottom line. Today, that’s Jantzi: Yes, it is more optimistic, because
investment community. Responsible investors flipped on its head. If you’re not looking at ESG more companies are paying more serious attention
and those of us who are charged with providing issues as part of the investment process, you may to ESG issues. Fewer companies are treating
insights into company performance need to be transgressing your fiduciary duty. sustainability as marketing or window-dressing
continue to find effective ways to measure how and more are integrating these issues into their
smaller companies are doing. So, the debate is still out there. But there’s an strategic decision making.
overwhelming amount of evidence that’s
It’s not fair to compare a small-cap company showing a positive correlation between sustain- But let’s step back for a moment and understand
to a large cap. From a Sustainalytics perspective, ability and shareholder value. The burden that we still have issues, like Volkswagen
we understand that and have developed of proof is now on those who think these issues recently, that highlight the fact that no matter
an analytical framework that reflects that. By the are not important to prove to us why they’re how good a job we’re doing, there are still
same token, whether you’re small or large, not. That’s a huge shift. going to be instances out there where companies
if you’re operating in a high-exposure industry, you are not meeting the sustainability standards
want to know that management understands the Looking ahead, what are some of the challenges we expect from them. We’re a long way from
risks that may be coming down the pike. surrounding sustainability and what issues will where we need to be, but certainly we’re heading
Those risks may not be there at this particular characterize the field, do you think, in the next decade? in the right direction and have been for the past
moment, but you want to understand whether that Jantzi: We’re going to continue to see growth two decades. K
management team is looking ahead. For us, it’s globally. We’re going to start to see sustainable
finding that balance between having lower investing extending beyond traditional equity Jon Hale, CFA, Ph.D., is Morningstar’s director of manager
research, North America. He is a member of the editorial
expectations than you would for their larger-cap and fixed-income asset classes. We’re already
board of Morningstar magazine.
brethren, but still understanding that the same seeing ESG being embraced in areas like private
issues can be out there lurking. equity, real estate, and infrastructure.
And then it’s part educational process on our We’ll see continued growth on the institutional
part to say to smaller companies—you need to side. Sovereign wealth pension funds have
12 Morningstar December/January 2016You can also read
