The rising pressure on universities and foundations to shed fossil fuel investments is stoking debate over whether it’s possible to invest in a way that delivers both societal benefits and competitive returns. To highlight two recent examples, Stanford University has said it will no longer invest in coal mines, and the University of Cambridge has pledged to act with “selflessness” in making environmentally and socially conscious investment decisions for its endowment.
These developments cast an uncomfortable spotlight on trustees and managers of endowments and foundations everywhere. Can they undertake environmental, social and governance (ESG) investing in a way that satisfies their activist constituents and yet also fulfills their fiduciary duty to fund future obligations?
The answer is yes. When done correctly, ESG investing can reconcile the concerns of the environmentally and socially conscious with the goals of the capitalist.
But the concern that responsible investing can hinder performance may explain, at least in part, why so few mutual funds follow this approach. A study published in April by the Commonfund Institute revealed that only 53 of the 200 U.S. colleges and universities surveyed invest using some form of so-called responsible practices. Only 8.5 percent of the respondents said they practiced ESG investing. Asked what impediments they saw to responsible investing, 15 percent had fiduciary concerns, whereas 36 percent feared lower returns.
The debate in certain industries, such as fossil fuels, illustrates the difficulty investors have in calculating the risks-versus-rewards of ESG-conscious portfolio management. Early approaches to socially responsible investing used a screening methodology to exclude certain companies based on their industry. But without consistent metrics to compare across industries and without complete data, these broad-brush screenings can produce questionable results. Such methods also tend to focus on risks while ignoring opportunities, such as the potential benefits of good ESG policies when implemented by corporate management.
Instead, we believe ESG must be integrated into the investment process — making the portfolio manager responsible for both the assessment of environmental, social and governance factors and the investment decision. In this way, contingent assets and liabilities, built up by companies that do ESG well and those that don’t, directly impact the portfolio.
In the case of fossil fuels, an integrated ESG approach will favor companies with a more sustainable business model. That might mean companies with a focus on renewable energy or companies that can extract oil inexpensively. Such an approach would avoid companies with reserves buried many miles underground in compromised geological structures that are expensive to access — a risk of financial loss from the denial of use of an asset — especially a concern when oil prices continue to be in a slump.
Of course, fund managers can’t be the only ones calling for more responsible investing. Ultimately, the decision lies with asset owners. Whoever pays the piper calls the tune, and endowments and foundations have an opportunity to dictate when and how they want an integrated ESG investment strategy to help drive performance.
What is clear is that integrating ESG adds a layer of analysis to the already challenging process of scrutinizing investments. What it can do: Yield better decisions.
Put simply: When it’s done right, ESG investing is good business.
Jeremy Richardson is a senior portfolio manager of global equities at RBC Global Asset Management in London.
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