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December 03, 2009

Investment Consultants Believe that ESG Considerations by Investors Are Here to Stay
    by Robert Kropp

The Social Investment Forum surveyed US-based investment consultants and found that while they expect client interest in ESG will continue to grow, many remain uncertain of the financial impacts. -- Investment consultants have been described as gatekeepers of the investment process. As Steven Lydenberg, Chief Investment Officer of Domini Social Investments, told in October, "Investment consultants serve as intermediaries between institutional investors and money managers, and have immense influence on the institutions. Their familiarity with environmental, social, and governance (ESG) and the options available is crucial."

With the momentum of incorporation of ESG factors into investment decision-making grows on a number of fronts, where do these gatekeepers stand in relation to providing information on ESG to their clients? A report issued this week, entitled Investment Consultants and Responsible Investing: Current Practice and Outlook in the United States, surveyed 41 investment consultants, and found that almost 90% expect client interest in ESG will continue to grow.

The report was authored by Meg Voorhees, Deputy Director of the Social Investment Forum (SIF), an association dedicated to advancing the practice and growth of socially responsible investing (SRI).

The survey of US-based investment consultants was adapted from a similar survey of European investment consultants conducted by Eurosif. Eurosif also issued its report, entitled 2009 Investment Consultants & Responsible Investment Study, this week.

The SIF report asked investment consultants "to indicate whether they advise clients on any of six ESG integration approaches," including proxy voting, corporate engagement, exclusion of stocks and bonds from a portfolio, integration of ESG analysis into investment decision-making, inclusion of best-in-class stocks and bonds in a portfolio, and positive selection according to themes of sustainable investment.

Acknowledging that such investment strategies are currently described by a number of terms, including SRI, "responsible investing, sustainable investing, ESG investing, mission-related investing or ethical investing," the report used the term ESG integration to describe them.

Nearly two-thirds of respondents reported advising their clients on so-called negative screening, or the exclusion of stocks and bonds from portfolios. Half the respondents also report advising their clients on integrating ESG criteria into investment decision-making, portfolio selection according to a best-in-class approach, and positive selection based on sustainability.

When asked about the impacts on portfolio performance of the six ESG integration approaches, a plurality of respondents indicated that only negative screening had a negative impact. The other five approaches were seen as positive by a plurality; however, "a quarter to a third of all respondents said they did not know whether the strategy had positive, negative or no impact," according to the report. spoke with Meg Voorhees, the author of the report, about some of its findings.

"Investment consultants know that client interest in ESG issues is not going to go away, and they realize that this is an area where they need to develop more expertise in their shops," Voorhees said. "Consultants are receptive, but some say they don't know about the financial impacts yet because there wasn't enough data over a long enough period of time."

The view held by the overwhelming majority of respondents that client interest in ESG considerations will continue to grow is based on their belief that their clients see the investment strategy as important, because of their desire "to be seen as responsible asset owners, and also to fulfill their fiduciary duty." According to the report, client interest will continue to grow due to the growing importance of a number of factors.

"A number of respondents mentioned climate change regulation, interest in green investing, and mission-related investing by foundations and endowments," Voorhees said. "One respondent said interest would grow because the US population is increasingly interested in issues of corporate responsibility."

The report found that only 22% of investment consultants proactively raise the issue of ESG integration with their clients, while a majority addresses the issue only after their clients raise it first. Some respondents, according to Voorhees, "Mentioned the Employee Retirement Income Security Act (ERISA) as putting something of a damper on consideration of ESG factors."

According to guidance on ERISA issued by the Department of Labor in October, 2008, "Plan fiduciaries, who are charged by law with the responsibility for operating employee benefit plans on behalf of plan participants, may never increase expenses, sacrifice investment returns, or reduce the security of plan benefits in order to promote legislative, regulatory or public policy goals that have no connection to the payment of benefits or plan administrative expenses."

"SIF members would say this was an incorrect interpretation of the guidelines," Voorhees said, "And would like to see more clarification." In December, 2008, SIF wrote to the outgoing Assistant Secretary of Labor to express its concerns about the guidelines, and later wrote to Phyllis Borzi, the Assistant Secretary of Labor for Employee Benefits Security under the Obama administration, asking her to follow up on the issue.

A strongly-worded recommendation to investment consultants on their responsibility to proactively address ESG issues with their clients came earlier this year, from the Asset Management Working Group (AMWG) of the United Nations Environment Program Finance Initiative (UNEP FI). In a report known as Fiduciary II, the authors stated, "Advisors to institutional investors have a duty to proactively raise ESG issues within the advice that they provide, and that a responsible investment option should be the default position."

Furthermore, investment advisors that fail to incorporate ESG issues into their investment services face "a very real risk that they will be sued for negligence," according to the Fiduciary II report.

"None of the respondents mentioned the Fiduciary II report," Voorhees said, "But that a primary motivating factor for clients was the desire to fulfill their fiduciary duty is significant."

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