Paper Examines Responsible Investing

In a paper released by The Commonfund Institute, “From SRI to ESG: Changing the World of Responsible Investing,” John S. Griswold, Commonfund’s executive director, William F. Jarvis, Commonfund’s managing director, and Lauren Caplan, Commonfund’s assistant general counsel, note responsible investing is more than a passing trend. The authors’ aim is to provide a guide to responsible investing for governing boards and committees who are considering whether and how to integrate environmental, social and governance factors into their investment process.

The paper reviews the principal categories and history of responsible investing, and discusses why socially-responsible investing (SRI), ESG investing, mission-related investing and impact investing have grown in importance for institutional investors. The authors look at fundamental arguments for and against ESG for long-term fiduciaries, as well as the impact ESG has on their institutions.

According to the authors, “ESG implementation does not need to be an all-or-nothing decision. Rather, a sliding scale of engagement is available for institutions that decide to explore ESG issues.” The authors also cite recent research that found the responsible investing market in the U.S. was estimated at year end 2012 to have $3.74 trillion in assets under management, representing 11.2% of the $33.3 trillion total assets under management in the United States.

The paper covers issues such as:

• The different approaches and purposes of SRI, impact investing and ESG;
• Responsible investing moving from a practice of negative screening and exclusion of certain types of investment to one seeking or encouraging certain characteristics in portfolio companies;
• Although SRI’s negative screening can be a useful tool for institutions desiring to express ethical, religious or moral values through their investment portfolio, for many it may prove too restrictive since SRI limits the range of securities available for investment;
• ESG analysis taking a broader view than SRI, examining whether environmental, social and governance issues may be material to a company’s performance, and therefore to the investment performance of a long-term portfolio;
• Whether a portfolio’s long-term performance can be enhanced by including ESG considerations in the security selection process;
• Users of ESG data calling for more standardized reporting mechanisms to improve the quality of data that is at the heart of any analysis of risk and materiality;
• ESG risk factors affecting company performance over the long term;
• Whether ESG investing is compatible with fiduciaries’ legal duties of care, loyalty and responsibility;
• Whether ESG is practice compatible with the Uniform Prudent Management of Institutional Funds Act; and
• How the broad category of alternative investments—such as marketable alternatives/hedge funds, private equity, venture capital, natural resources, commodities, real estate and distressed debt—pose challenges to traditional ESG analytical methods because of the relatively opaque nature of their investment processes.

The paper cites the 2012 NACUBO-Commonfund Study of Endowments, which found among U.S. institutions of higher education, 18% of the 831 responding institutions used at least one of the ESG criteria in managing their portfolios. In addition, the authors cite the 2012 Commonfund Benchmarks Study of Foundations, which reported that among U.S. public and private foundations, the use of ESG criteria is more limited, with only 9% of responding institutions saying they use ESG in their investing process.

The white paper can be downloaded here.