ESG and environmentally sustainable investment are increasingly capturing the attention of the institutional investment community. To assess the state of ESG and sustainable investing and how they are changing, Commonfund Forum 2021 offered a discussion focused on these topics featuring three Commonfund leaders with extensive experience. The objective of the session was to share actionable ideas that fiduciaries can take back to their boards and investment committees to advance their adoption of responsible investing practices.
The discussion participants were Deborah Spalding, CFA, Co-Chief Investment Officer, Commonfund Asset Management Company, and Ethan Levine, Managing Director, Commonfund Capital. Ms. Spalding broadly leads Commonfund’s ESG and sustainability efforts, while Mr. Levine serves in the same role for Commonfund Capital. The discussion was moderated by Daniel Connell, Director, Commonfund Capital.
The following captures key takeaways coming out of the exchange of views.
What should we know about ESG’s evolution in recent years?
Spalding: While we continue to see exclusionary investing, particularly around fossil fuels, many investors are moving beyond the exclusionary approach to incorporating ESG into the portfolio construction process as well as actual investment selections. That can include investing in companies implementing ESG efforts, even if they operate within sectors that are considered environmentally dirty. Other investors are looking to tilt portfolios to take advantage of emerging trends, such as the transition to a low carbon economy. There has always been a recognition that performance is enhanced when corporations are well governed. And there’s increasing recognition that corporate performance is better when there is a diversity of talent across the organization.
Levine: When you look back five, 10 years and asked folks in the private capital community about ESG, many people wouldn’t even know what the acronym stood for. Today there’s a dramatic difference wherein people not only understand what it means, they take it seriously. Many firms are actively tracking portfolio metrics as they relate to ESG. And it’s become much more commonly used in the due diligence process. Historically, it was viewed as a risk management tool that would flag any issues related to the environment, social issues or governance. Within the private capital industry, we’re usually less concerned about governance because a lot of what’s done in private capital involves buyouts that typically lead to better governance. So, that has put the focus on the environmental and social side. In sum, in the private capital world, ESG has moved from a “nice to have” to necessary.
How do you see the landscape today in terms of investor interest and demand?
Spalding: There has been increased interest in ESG, broadly speaking, in both public and private markets. There are still investors on the sidelines, particularly in the public markets. Some of that has to do with the fact that there has been the lack of a verifiable ESG track record. As ESG has evolved it has come to mean different things to different investors … there’s no single index or track record to point to. Data can still be hit or miss. Now, that being said, we’ve come a long way and it’s fair to say that the voices in favor of ESG are growing louder than the voices of the skeptics.
Levine: The interest in ESG has moved from conceptual to an actual commitment of investment dollars. To Deborah’s point, there is still some skepticism as it relates to performance and track record. But what has changed is that actual data points exist, demonstrating the ability to generate standalone financial risk-adjusted returns. You can act as a fiduciary and invest in these areas. The measurement side is also improving … it’s not as abstract. Looking forward, people see ESG as a source of resilience within a portfolio.
From the purely investment perspective, not just investor appetite, how has the investment landscape evolved?
Spalding: I think historically, one of the challenges has been that asset management is a scale business. So, the more assets seeking a strategy, the greater the incentive for the marketplace to offer that strategy. Now, as more investors are seeking out ESG investments, or even ESG-aware investments, the industry is starting to rise to the challenge.
Levine: Ten–plus years ago a lot of the focus was on early-stage venture. But there has been an ongoing evolution and a maturation of those markets so that today you can invest in more growth equity and buyout-related exposures, which can offer a differentiated type of risk/return profile. The other area of change is the shift from broad impact funds to funds that are focused … perhaps more on the environmental side or on the social side, or even on different geographies. It could also be a health care-focused fund or education-focused fund. Today, you have expertise and talent in these subsectors and that has the potential to lead to more interesting returns.
What’s the likely trajectory going forward, not just now, but in five-plus years?
Spalding: Already, we are seeing ESG becoming a mainstream component of manager diligence and that’s likely to increase. The quality of questions and the quality of the vetting will only get better in terms of sourcing investment managers. One area that we see emerging very quickly is investing around diversity, equity and inclusion. Some investors include this within ESG and some don’t. Whichever way it is viewed, this is something that we expect to continue to be embedded in the manager selection process as well as in direct investments in diverse businesses. We’re very optimistic that this will continue to grow and that investors will begin to recognize not only that ignoring it is a potential risk, but that it can also have positive investment and societal impacts as well.
Levine: When we look back in a few years, people will be utilizing these themed investments in their portfolios because they will be way beyond using ESG simply as a risk management tool. These types of investments can enhance a portfolio, reduce volatility, provide greater resilience and gain exposure to secular growth trends. We talked about measurement … right now the goal should be capturing those metrics. In several years, the goal should be benchmarking them as data sets get more robust, e.g., is this a good number or is it not a good number? Finally, there is investor preference. There might be a preference for the environmental side or for health care because it might tie to institutional mission. There will be increased ability to customize around some of these investments and tailor bespoke exposures.
Opinions expressed in AGB blogs are those of the authors and not necessarily those of the institutions that employ them or of AGB.