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August 28, 2008
ESG Criteria Creeping Slowly into Mainstream Investing
    by Anne Moore Odell

New report lays out the five hurdles ESG investing has to clear before it can be incorporated on a large scale.

There still isn't enough long-term data about the impact of environmental, social and governance (ESG) criteria on investments finds the report, "Environmental, Social Governance: Moving to Mainstream Investing?" Yet more and more mainstream financial institutions are developing ESG frameworks and are assessing the impact of these ESG frameworks on returns.

Published by the nonprofit business association Business for Social Responsibility (BSR), the report explores whether or not mainstream investment firms are incorporating ESG criteria as part of their overall investment analyses. The report then looks at when ESG is not part of mainstream investments and explores some of the potential reasons why not. The report was written by Anu Yegnasubramanian as part of the Advanced Policy Analysis project at the Goldman School of Public Policy at the University of California, Berkeley.

By completing a review of reports--such as "PRI Report on Progress 2007" findings from the United Nations Environment Programme Finance Initiative (UNEP FI), ESG frameworks from mainstream financial institutions, and by considering a summary of perspectives shared during a series of interviews, BSR's report summarizes what is happening currently in mainstream financial institutions in regards to ESG issues. The report then looks at both the stumbling blocks to ESG's progress and offers solutions to removing these blocks.

The most important sign of ESG's impact is the out performance of investments that use ESG criteria against an accepted baseline the report concludes. However, ESG criteria and studies on its effects on returns suffer from a lack of data over time, as most data on ESG criteria doesn't extend very far into the past, certainly not the ten years most analysts look at.

"Goldman Sachs' GS Sustain Focus List, which predicts the top corporate performers primarily by evaluating how well they integrate ESG criteria into their businesses, has outperformed the world stock index MSCI by 25% since August 2005," said Laura Commike Gitman, director of Advisory Services for BSR.

The report lays out five barriers to mainstream investing adopting ESG criteria and suggests possible solutions for breaking down the barriers. The first barrier to ESG going mainstream is the lack of data and financial information on the effects of ESG for the long haul.

"I believe that companies and investors need to shift attention from quarterly earnings guidance to investments and management decisions that focus on the long term growth and sustainability of the company," Gitman said.

The report's author suggests offering incentives for institutions completing long-term research on the incorporation of ESG criteria onto returns. By using well-known market effects models, mainstream investors can place ESG criteria in a larger context.

Insufficient reporting of ESG data is another barrier to integrating ESG criteria into mainstream investing. Although more companies are publishing corporate social responsibility (CSR) and sustainability reports, the information in the CSR reports, from company to company, varies widely. BSR's report suggests that governmental regulations on CSR reporting and mandatory ESG reporting by companies could help address this barrier.

The third barrier to the inclusion of ESG criteria into the mainstream is the focus on short term investing. A shift in the investment culture would need to take place to move investors to think about the long-term. Gitman points to the Aspen Institute's report "Long- Term Value Creation: Guiding Principles for Corporations and Investors" as a great resource for investors looking at longer lasting investments.

Investment professionals need to build capacity regarding ESG criteria the report lists as the fourth barrier to change. The report reads: "conversations with investment professionals in niche sustainability financial institutions portray a similar picture of mainstream investors as being primarily trained to assess fundamental financial data and not fully equipped to analyze ESG criteria."

The solution is the education of current investment professionals and the inclusion of ESG issues and awareness at the college level. Financial institutions could also purchase ESG ratings to help build capacity.

The last barrier to the inclusion of ESG criteria into the mainstream is the mindset and cynicism of mainstream investors. Cynicism can be beaten in a number of ways, most importantly, by showing that including ESG considerations improves the bottom line. By talking with many different stakeholders, new perspectives can be gained and distrust of ESG criteria lost.

"SRI is often seen as a separate type of investment that is focused on the dual goals of both financial and social/environmental impacts," concluded Gitman. "For ESG criteria to become integrated into all investments, investors need to believe that these dual goals are inextricably linked. How companies manage their ESG performance is a strong indicator of a company that is well-managed overall, one that will achieve superior financial performance over the long-run."


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