By Rose Ors
In collaboration with Amelia Miazad, Founding Director & Senior Research Fellow, Business in Society Institute, Berkeley Law
April 10, 2019
Some have called 2018 the tipping point of the movement to integrate Environmental, Social, and Governance (ESG) criteria into investment decisions. The Forum for Sustainable and Responsible Investment reports that at the start of 2018, $11.6 trillion of professionally managed assets—$1 of every $4 invested in the United States—were under ESG investment strategies. In 2010, the amount was close to $3 trillion overall.
I spoke to Anne Sheehan, Chair of the SEC’s Investor Advisory Committee, who last March retired from CalSTRS after 10 years as the Director of Corporate Governance, about the evolution of sustainability during her tenure at CalSTRS and beyond.
Rose Ors: How do you define sustainability?
Anne Sheehan: Traditionally, sustainability was viewed as non-financial material information that could affect the operation of a company and potentially affect the company’s financials. At CalSTRS the perspective we had was that there are risks and opportunities today which can have an impact on the cash flows of tomorrow. How well a company manages those risks and takes advantage of those opportunities is one way to determine how sustainable their returns will be over the long-term.
The questions that investors are asking about sustainability today are reflective of that long-term approach. They want to know how companies approach managing human capital and risk throughout the supply chain. Oversight of climate risk and diversity are two subjects that many investors are looking to engage on with Boards and management teams. Those aren’t new topics this year, but they have become much more prevalent in the past several years.
Rose Ors: You led corporate governance at CalSTRS for ten years. What changes did you see in ESG and sustainable investing during that time period?
Anne Sheehan: What I saw from the day I started at CalSTRS and everyday thereafter was an ever-increasing focus on ESG investing. That said, even before my tenure, CalSTRS had a long history of considering environmental factors in making investment decisions. G or governance was always in our DNA. Governance affects the E (Environmental) and S (Social) in ESG because it shapes the lens used to make investment decisions. During my time in Sacramento, I also saw the development of the United Nations-supported Principles for Responsible Investing (PRI) and the inception of the Carbon Disclosure Project—both big pushes that investors got behind because they recognized the importance of establishing frameworks for integrating ESG factors into investment analysis. I managed the sustainable portfolio at CalSTRS and help helped decide which of the low carbon funds we would invest in. During this time period, we moved from engaging and asking companies about their ESG practices, to a full-fledged integration of the ESG lens.
But there’s more than one reason why ESG as a concept has taken off. One is the speed with which we can obtain information. Whereas in the past we had to wait for a company’s annual 10K to get the latest company information, social media reduces the time lag from months to minutes. That has had a direct impact on how companies communicate with all of their stakeholders. Another is generational – the men and women entering the workforce today are paying much closer attention to the values and mission of the companies they are investing in and working for. Lastly is the shift in the investor community that has resulted from these global regimes like the PRI. Today you have huge investors like BlackRock and State Street asking their portfolio companies to disclose ESG data and report along sustainability disclosure frameworks. All of these have heightened the market’s understanding of how ESG and financial returns fit together.
Rose Ors: The investor landscape has shifted dramatically since the financial crisis. How has the shift to passive investing changed how companies and investors think about sustainability?
Anne Sheehan: The shift to index or passive investing has changed the conversation around sustainability. When you are a passive investor, you invest for the long haul. It is a very cost-effective way of investing because the strategy requires a buy-and-hold mentality. For investors like CalSTRS—which has half of its $225 billion portfolio in global equities and almost three quarters of that in index funds— the approach was, and still is, to be passive investors and active owners.
Around the time I started at CalSTRS, only about six percent of S&P 500 companies reported engaging with their investors. Today that number is more than three-quarters. Many of those engagement conversations are focused on ESG topics, whether it’s board composition, human capital or environmental issues. Every investor takes a different approach to engagement which is one of the challenges for companies as they navigate this changing landscape. But even a topic that is local for a California fund like CalSTRS such as water management and water supply is also an issue with global implications.
Rose Ors: One issue that many companies and investors discuss is the complexity of navigating the data and tools needed to assess progress on sustainability. Is there a solution?
Anne Sheehan: While there are several ESG frameworks in the market, right now there is no one single path that every company can follow. You hear a lot from companies about ‘survey fatigue’ where they are asked to provide the same or slightly different information to a myriad of service providers, ratings agencies and others. This approach isn’t sustainable. Investors are cognizant of the need to help companies in this regard which is why I think many of them have started to coalesce around the Sustainability Accounting Standards Board reporting model, which really seeks to help companies identify and disclose the material risks to their business.
Rose Ors: There is also the concomitant issue raised by a lack of a single reporting framework—the inability to compare apples-to-apples.
Anne Sheehan: Absolutely. If you lack reporting consistency, you lack the ability to look at two or more companies in an industry sector and readily ascertain how they address a particular ESG issue.
Rose Ors: What does the future hold for sustainable investing?
Anne Sheehan: One of the things I saw just as I was leaving CalSTRS was the rise of impact investing on the private equity side. Some of the big PE firms have begun to invest in sustainable businesses. So, I believe ESG factors are going to play a role in different asset classes, including in the private markets and on the debt side. I think the demand for this overlay will, in part, be driven by millennials as well as university endowments and pension funds. This will be accompanied by new standards on ESG reporting for these classes and growing demand for ESG tools and data to assist in evaluating companies on these metrics. Sustainability has come a great distance over the past ten years, and there’s still many more miles to go.