- Blog Post
- Blog posts represent the views of CFR fellows and staff and not those of CFR, which takes no institutional positions.
This post features a conversation with Audrey Choi, chief executive officer of Morgan Stanley’s Institute for Sustainable Investing and managing director of its Global Sustainable Finance Group. Choi talks about the evolving $20 trillion sector, including important U.S. policy changes and her thoughts on where sustainable investing is headed.
1) What does sustainable investing mean, and how has it evolved in recent years?
There has been an evolution in sustainable investing over the past five to ten years in both definition and practice. Investors have moved away from predominately avoiding—or divesting from—industries and companies considered harmful toward taking a more proactive approach as well. They are pursuing positive social and environmental impact while also expecting competitive financial returns.
Traditionally, there was a tendency to divide investing and philanthropy, using the first to build wealth and the other to make a positive social difference. Sustainable investing, which includes values-based, environmental, social, and governance (ESG) integration, thematic investing, and impact investing approaches, allows investors to align their values or mission with their investment portfolio.
Another shift has been the increase in research addressing the misconception that doing good requires a financial trade-off. Harvard University and Brookings compared a portfolio of companies that performed poorly on sustainability with a portfolio of companies that performed very well on the same issues. One dollar in the low performance portfolio grew to $14.46 between 1993 and 2014. The same dollar in the high performance portfolio rose to $28.36 over the same period.
And at Morgan Stanley’s Institute for Sustainable Investing, we examined ten thousand mutual funds across seven years of performance, comparing sustainable to traditional investing strategies. We found that 64 percent of the time, sustainable strategies performed either the same, or slightly better, than traditional ones. Meanwhile, volatility for those strategies was the same, or slightly less, 64 percent of the time.
Finally, the University of Oxford conducted a meta-analysis of over two hundred studies and found that incorporating ESG business practices resulted in better operational performance, lower cost of capital, and better stock price performance.
We’re also seeing a shift in how sustainability factors into stock and company valuations. More and more investors and analysts are asking how to incorporate ESG into existing models of valuation. Whether a multinational company disposes of waste responsibly, monitors its water usage, and recycles increasingly matters. Sustainability efforts are more than corporate reports—they are considerations that can be materially relevant to core business practices and results.
2) How is “sustainability” measured, and what counts as sustainable investing?
We take the broad view that sustainable investing encompasses both financial sustainability and environmental and social sustainability. As part of the sustainable investing evolution, there has been a great deal of work in the field to better understand the type of sustainability considerations that can have both real business and investment impact. The United Nations Principles for Responsible Investment (UNPRI) and the Sustainable Accounting Standards Board (SASB) are two important examples of increasingly-recognized bodies developing standards and frameworks for measuring and reporting on sustainability.
UNPRI has not only established what responsible investment should entail, but as a membership organization, it is a platform for signatories (asset managers, owners, and service providers) to express their commitment to a more sustainable global financial system.
And SASB has created standards for ESG considerations across eighty industries, helping public corporations disclose material issues to investors. As part of its standard-setting work, SASB found that climate change alone affects seventy-two of seventy-nine industries—each in specific and different ways. That’s 93 percent of the capital markets, or $33.8 trillion dollars.
3) How does sustainable investing compare to philanthropy or development aid, through NGOs and others? Are there some areas that should be left to private donors rather than investors?
Ultimately, driving large-scale positive social and environmental change requires government, philanthropy, and investment dollars to work in common cause. Tax dollars and philanthropy alone are not sufficient to fix the world’s problems. Private investment can play a crucial role in filling that gap.
Still, sustainable investing should not be seen as a replacement to philanthropy. Indeed, there are critical situations when philanthropy and government aid should be the first resort, such as when an immediate response is required, as in humanitarian efforts and disaster relief. Aid is critical in these instances where financial returns, cannot, or should not, be expected.
But governments and philanthropies also play critical roles as catalytic investors. They provide the visionary risk capital to enable discovery and innovation, setting the stage for future markets. For example, microfinance began as a donor-led space, eventually growing to a robust field where private sector investment has enabled scale and reach.
4) What are the U.S. rules and regulations that have helped, or hindered, sustainable investing?
In the U.S. context, one of the most important recent changes was the revision to U.S. Department of Labor guidance around ESG investing for Employee Retirement Income Security Act (ERISA) plans, announced late last year by Secretary Thomas Perez.
Employee retirement plans, such as pension funds or 401(k)s, are bound by the ERISA, which sets a fiduciary duty, or legal obligation, for managers to act in the interest of plan participants.
In October 2015, Secretary Perez and the Department of Labor issued a clarification that “environmental, social, and governance factors may have a direct relationship to the economic and financial value of an investment.” Rather than an external and separate consideration, ESG factors could now be considered relevant in evaluating an investment’s economic qualities. This clarification went a long way in addressing the perception that ESG consideration might be at odds with fulfilling fiduciary duty.
Globally, another important development was the Paris Climate Conference (COP21) agreement that set binding targets to limit global emissions. It sent a clear signal of change that may open new conversations on ESG and sustainable investing, as well as the inclusion of climate change-related risk as a material financial consideration.
5) Looking ahead, what is the outlook for sustainable investing, in the short and long term?
Within ten to fifteen years, we believe sustainable investing should be perceived as a redundant term. Sustainability considerations will be a part of a best-in-class investing thesis, rather than being a separate analysis.
Just as political and cyber risk has become a core part of the risk and return analysis, so too do we believe that sustainability factors will become a core part of risk and return analysis.
There has already been impressive growth in the field. In 2012, the U.S. Sustainable Investing Forum reported one out of every nine dollars invested in the United States had some type of sustainable mandate to it. From 2012 to 2014, that figure grew by 76 percent to one out of every six dollars. Though the starting point was small, we are seeing rapid growth, with more than $20 trillion dollars now invested in the sector globally.
Another driver of change in sustainable investing is the influence of millennials. Compared to other generations, millennials are three times as likely to pick an employer based on their ESG performance. They are also twice as likely to check product packaging for sustainable sourcing information before they choose a product.
And this philosophy carries over to their investing decisions. Millennials are twice as likely to check a mutual fund or equity investment and choose it because of sustainability, and twice as likely to divest—or walk away—because of objectionable corporate activity.
As this generation is set to inherit more than $30 trillion in the United States over the next thirty to forty years, it will be significant how they integrate their sustainability priorities into their investment decisions going forward.