Amid the growing support and pushback on the use of ESG criteria for investing, a new white paper seeks to establish the use of a consistent terminology when describing ESG integration and sustainable investing strategies.
“By providing a simple, consistent terminology, the working group hopes the document will also help improve the public’s understanding of ESG investing and help inform those who are interested in ESG investing about the many choices that funds provide,” the Investment Company Institute explains in “Funds’ Use of ESG Integration and Sustainable Investing Strategies: An Introduction.”
The white paper was written by the ICI’s Environmental, Social, and Governance Working Group consisting of senior executives from ICI member firms and was approved by the organization’s Board of Governors.
“As demand for ESG investing continues to grow, it’s important that the fund industry and its shareholders have a common understanding of the various terms and techniques involved,” said George C. W. Gatch, ICI’s chairman and CEO of J.P. Morgan Asset Management. “This publication provides a very solid roadmap to help promote a greater understanding of the dynamic ESG investing landscape.”
The Continuum
The ICI’s paper attempts to help distinguish between the different ways fund managers consider ESG factors across a broad investing spectrum. The publication notes, for example, that for decades some funds have integrated ESG factors into their investment processes to the extent that they are financially material. As such, they seek to enhance fund performance, manage investment risks and identify emerging investment risks and opportunities—much as they would consider macroeconomic risks, business risks or other considerations.
Moreover, the paper notes that not every fund integrates ESG factors in the same manner; rather, there are a range of qualitative and quantitative approaches for embedding ESG across investing strategies, spanning asset classes and active to passive strategies.
For example, the ICI notes that funds that have a sustainable investment strategies use ESG analysis as a significant part of the fund’s investment thesis to meet investors’ objectives while seeking financial returns. Some funds integrate analysis of ESG factors, others use one or more sustainable investing strategies, and some integrate ESG factors and employ one or more sustainable investing strategies.
To that end, the ICI describes how funds pursue sustainable investing strategies using three nonexclusive approaches:
- ESG exclusionary investing: Funds using an ESG exclusionary investing approach may exclude companies or sectors that do not meet certain sustainability criteria or do not align with investors’ objectives. For example, a fund may not invest in companies that have significant business related to weapons manufacturing or distribution, gambling, tobacco, alcohol or nuclear energy.
- ESG inclusionary investing: Funds using an ESG inclusionary investing approach generally seek positive sustainability-related outcomes by pursuing and focusing on portfolios that fundamentally or systematically tilt a portfolio based on ESG factors alongside financial return. For example, the ICI notes that a fund may invest in equity securities of companies that contribute to and benefit from clean energy generation, sustainable infrastructure, waste management and other environmentally friendly approaches.
- Impact investing: Funds using an impact investing approach seek to generate positive, measurable, and reportable social and environmental impact alongside a financial return. Measurement, management and reporting of impact is a defining feature of impact investing. Here, the paper observes that a fund may invest the majority of its assets in securities whose use of proceeds, in the fund manager’s opinion, provide measurable positive social or environmental benefits.
DOL Pushback
ICI’s paper comes as the Department of Labor attempts to clamp down on private employer-sponsored retirement plans using ESG criteria to make investment decision by issuing a proposed regulation to clarify investment duties of ERISA plan fiduciaries in relation to ESG investing.
Similarly, the SEC announced in March that it was examining whether the current requirements that restrict the use of potentially misleading fund names—including the growing use of funds with investment mandates that include various criteria, such as ESG factors—are still effective and that it was seeking comments on whether there are viable alternatives.
The DOL has received quite a bit of pushback from House and Senate Democrats who argue that the proposal is out of step with what investors want and that ESG investments outperform others. Other industry groups, including the ICI, are pushing for an extension of the department’s 30-day comment period.
