Beats | June 19, 2018

The M-word: Investors bring ESG into the material world

The team at


The ESG ship has sailed, whether the Trump administration likes it or not.

A spate of recent surveys suggest that consideration of environmental, social and governance factors in investment decision-making has become accepted, if not required, practice for asset owners and managers worldwide.

The shift toward ESG investing has turned on a simple, yet critical, concept: materiality. In the latest episode of ImpactAlpha’s Returns on Investment podcast, our regular roundtable parses the April memo from the Department of Labor that tried, albeit weakly, to walk back Obama-era guidance that “fiduciary duty” could include consideration of such factors.

The Impact Alpha: Prudence, materiality and impact in the Trump era

“As that wise sage Madonna once said, ‘We are living in a material world,’” says Returns on Investment host Brian Walsh in teeing up the discussion. (‘Cause the boy with the cold hard cash Is always Mister Right.’) Yes, he did then really ask Imogen Rose-Smith, “So, are you a materiality girl?”

The ‘M-word’ runs through Labor Department’s new memo, which was intended to help pension plan managers (some of whom are regulated under the Employee Retirement Income Security Act of 1974, or ERISA). The memo says fiduciaries “must not too readily treat ESG factors as economically relevant” and that “it does not ineluctably follow” that investments that promote ESG factors, or even positive market and industry trends are a prudent choice.

The fiduciary’s evaluation, the memo advises, “should be focused on financial factors that have a material effect on the return and risk of an investment” over the plan’s time horizons.

Given that environmental and social issues, starting with climate change and income inequality, inarguably will have material effects on asset values in the 30-, 40- or even 100-year timeframe of pension and sovereign-wealth funds, that materiality standard would seem easy to meet. Governance factors are even more immediately relevant. A Bank of America Merrill Lynch study found that investors who used above-average ESG scores to guide their stock picking would have avoided 15 of 17 corporate bankruptcies between 2008 and 2016.

That is, there’s no reason for fiduciaries who feel they are best serving their clients by accounting for long-term risks and opportunities to step back. “If you’re waiting for the Department of Labor and the Securities and Exchange Commission to tell you what it means to be a fiduciary, you’ll probably never be a good one,” Scott MacKillop, CEO of First Ascent Asset Management in Denver, wrote in a recent post (h/t Mo Shaffroth).

A new survey from Morgan Stanley of nearly 120 pension and sovereign wealth funds, insurance companies, endowments and other large asset owners found that nearly half already have implemented ESG strategies across their entire portfolios, and another 21% use ESG in a portion of portfolios. Risk-mitigation is the biggest driver (78%), but higher returns is close behind. The results were similar in an Aon survey of institutional investors, which found that 40% have ESG policies in place and another 14% are implementing them.

Knife to a gunfight

When the new memo was released, some impact investors seemed to take the bait, with reactions that protested that shareholder supremacy is outmoded, as is profit-maximization. In the podcast, I argued that, while true, such comments confirmed the critics’ charges that considering of non-financial factors sacrifices, says, retirement security for some kind of social or environmental pet causes. “That’s a weaker argument than to say, ‘No these are material risks. These are things you should take into account as your fiduciary responsibility. You are the ones playing with fire for pension holders.’”

Rose-Smith cautioned that impact investors shouldn’t feel too smug. “We know climate change is having a long-term effect. We know that over time there has to be a shift to low-carbon. That doesn’t mean I know the material affect on my investment portfolio over the short- and medium-term,” she said. “I can’t ignore what is going to happen in the next day, weeks, months or years.”

Rose-Smith said the section of the memo around shareholder engagement could have the more significant effect. Four out of five of the respondents in the Morgan Stanley survey said they participate in direct shareholder engagement around environmental, social and governance issues. In particular, majority shareholder votes for climate-risk resolutions at companies like Exxon-Mobil and Occidental Petroleum have spooked many companies.

As shareholders get active on climate, the SEC lets companies duck votes

“The impact investors have taken a knife to a gunfight,” Rose-Smith says. Corporations don’t want their employee pension plans to weigh in on workplace, climate or other issues. Between the lines, the Department of Labor was setting rules for large companies and labor unions. “These groups are powerful and good at lobbying, much more so than the impact community, which is microscopic,” Rose-Smith says.