Running the Fund:Looking Ahead Responsibly
Experts anticipate the increasing importance of ESG for plan investors
Ask Adam Strauss, a portfolio manager at the Chicago-based Appleseed Fund, to describe the way he evaluates and selects investments, and he will give an answer similar to that of many active managers.
“We’re stock pickers, so what we’re looking for is to invest in high-quality companies with stocks that are significantly undervalued,” Strauss says. “And we look very closely at balance sheets. If a company experiences a temporary problem in the business but the balance sheet is strong, you’ve got lots of time on your side to turn things around. If it’s weak, then that’s working against you.”
It is only after discussing pricing power and competitive advantage that he brings up the term “sustainability” or “ESG,” short for environmental, social and governance. The term has become shorthand for investment methodologies that consider sustainability factors in assessing risk and return.
ESG considerations can involve anything from an investment’s carbon footprint to its sensitivity to potential resource or energy shortages. Other elements include investment chain alignment, transparency and active asset ownership.
Strauss says the Appleseed Fund incorporates ESG not only to ensure that shareholders own environmentally and socially responsible companies but also as a means of eliminating risk and boosting potential returns.
“Our goal is to beat the market, so we’re very focused on delivering returns and doing it with less risk,” Strauss says. “We’ve beaten the markets by several percentage points per year since starting in 2006, and we’ve also delivered an extremely low beta.”
Interestingly, it is the traditional risk and return factors that will be most important for ESG funds, as they are for all funds, when it comes to penetrating the retirement planning marketplace. That is because the Department of Labor (DOL) has affirmed in a number of advisory publications—especially two issued in 2008 by its Employee Benefits Security Administration (EBSA)—that ESG factors must be considered secondarily to the economics of any investment being contemplated by a plan under the Employee Retirement Income Security Act (ERISA).
In other words, according to the DOL, noneconomic factors can serve at most as a tiebreaker when retirement plan fiduciaries are considering investment choices. That holds true even for plans at issue-dedicated nonprofits and other social organizations, where participants may be more willing to consider ethics during the investment process.
Despite the fiduciary hurdle, experts anticipate certain ESG factors—namely, climate risk, energy pricing and resource scarcity—to become significantly more material in long-term investment analysis and therefore to become more important to retirement plan investors in the years ahead.