Institutional Investors Increasingly Including ESG Factors in Portfolios

Callan’s recently published “2021 ESG Survey” found that 49% of institutional investor respondents incorporated environmental, social and governance (ESG) factors into their investment decisionmaking processes, up 7 percentage points from the previous year’s level and more than double the share in 2013.

In addition, 40% of respondents that are not yet incorporating ESG approaches were considering doing so, the highest share in the survey’s nine-year history and more than three times the level as recently as 2019.

This year’s survey reflects input from 114 U.S. institutional investors. Respondents included public and corporate defined benefit (DB) and defined contribution (DC) plans, as well as endowments and foundations, with assets under management (AUM) ranging from small (less than $500 million) to large (more than $20 billion).

Public plans (63%) incorporated ESG factors at the highest level among survey participants. They were closely followed by foundations (57%) and endowments (50%). Only 20% of corporate plans incorporated ESG, a trend in line with the survey’s findings over the years.

The most frequently cited reason respondents gave for incorporating ESG into investments was to align their portfolio with their values (55%), followed closely by fiduciary responsibility (54%).

According to the Callan survey, nearly two-thirds of investors that incorporated ESG approaches communicated to managers that ESG was important to the fund or considered ESG factors with every investment/investment manager selection. This finding falls in line with Russell Investments’ seventh annual “ESG Manager Survey,” which found 60% of managers globally identify climate change/environmental issues as their clients’ top ESG concern.

The Russell survey of 369 global asset managers, representing $79.6 trillion in AUM across a broad range of asset classes, found asset managers are placing greater emphasis on active ownership of their investments and increasingly engaging on ESG issues with the underlying companies in their portfolios.

More than 80% of managers surveyed explicitly incorporate qualitative or quantitative ESG factor assessments into their investment processes. This is reflected in the extent to which ESG factors are now influencing investment decisions, particularly with respect to risk. Forty-six percent of respondents noted the material role ESG factors such as climate change play in assessing potential security risk (an increase of 11 percentage points since 2018). Furthermore, 29% of managers highlighted the influence of ESG considerations in driving positive returns, a rise of 9% since 2018.

Similar to previous years, managers continue to rank “governance” (80%) as the most important ESG factor that impacts their investment decisions, reflecting the importance of company management in delivering long-term enterprise value regardless of industries. Meanwhile “environmental” has increased over the past four years from 5% in 2018 to 14% in this year’s survey.

Survey respondents said they hear from clients (i.e., asset owners) more on climate risk/environmental issues (60%) than any other issue, followed by diversity and inclusion/social issues (20%).

“ESG integration within asset management investment and business practices has continued to evolve at a fast pace, with forward-looking materiality assessments being the key consideration,” says Yoshie Phillips, director of investment research – global fixed income, at Russell Investments. “Asset managers are applying more rigorous ESG-related analysis and seeking to provide greater transparency. However, there is still much progress to be made, particularly with respect to climate change, which is increasingly defining ESG agendas and ranks as the No. 1 concern among underlying clients.”

Callan’s recently published “2021 ESG Survey” also highlighted data from the proprietary Callan DC Index and the “Callan DC Survey” and reported that 13% of DC plans offered a dedicated ESG option. Usage by plan participants remained low, however, with an average allocation of 1.2%. But there has been a steady increase in the share of plan sponsors that added an ESG option in the year prior to the publication of each “DC Survey.”

Participant use of ESG investment options in DC plans could see an uptick, however, as Natixis Investment Managers’ survey of 8,550 individual investors from 24 countries found 45% consider it important to invest in companies that are transitioning to more sustainable business models. Two-thirds (67%) say they would be more inclined to invest in funds that demonstrate a better carbon footprint, a key factor in reducing climate change.

Natixis’ survey busted the conventional wisdom that ESG adoption has been driven by socially conscious Millennials who want their assets to drive environmental, social and ethical change. While ESG investors do skew younger, broad adoption and interest suggests ESG investing now appeals to mainstream investors. One in four (27%) Millennials say they are invested in ESG approaches, but so do 20% of those in Generation X and 18% of Baby Boomers. Moreover, interest in ESG investing is high across all age segments, including 52% of Millennials, 52% of Generation Xers and 44% of Baby Boomers.

Only one in five investors believe that investing in ESG approaches means sacrificing investment performance. Investor sentiment has shifted dramatically since 2017, when Natixis found 64% of investors surveyed believe they would need to sacrifice some return potential to have investments that match their personal values. Just 22% say a lack of information on non-financial performance keeps them from allocating to ESG investments.

“First, we were surprised to see that there was a higher percentage of investors in North America (28%), and more specifically the U.S. (32%) who said they are invested in ESG strategies,” says Dave Goodsell, executive director of Natixis Investment Managers Center for Investor Insight. “The common assumptions would be that Europeans would be more likely to invest in ESG, but only 22% in the region say they do today.

“We were also surprised to see that investors look at ESG with a sort of enlightened self-interest. The individuals we surveyed were just as likely to see financial potential of ESG as much as the environmental and social benefits. That goes hand in hand with the trend we’ve seen with institutional investors in recent years,” he says.

Goodsell adds, “Since we first started polling on ESG, the financial rationale has become clearer for institutions as well. In 2015, institutions most often told us they invested in ESG because it was mandated by their investment policy statement. Since then, more institutions are finding that ESG offers alpha potential (10% in 2015 vs. 62% in 2021) and the potential for better risk adjusted returns (15% in 2015 vs. 29% in 2021).”