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March 21, 2016

Social and environmental investments yield more than economic returns

Photo / Peter Van Allen Tom Manning (left), CEO and president, and Robertson P. Breed, senior vice president and portfolio manager, of F.L. Putnam Investment Management Co. They are standing on the balcony of F.L. Putnam's office on Commercial Street in Portland.

Investing in social and environmental causes used to be associated with tree huggers and other “do-gooders,” but in recent years it has hit the mainstream, with returns equaling or sometimes exceeding those of other stocks in a portfolio.

Investors can put money behind causes or values important to them, like stocks of companies that support underserved communities, that have sustainability goals or have ethical practices as part of their corporate governance. It's called environmental, social and governance, or ESG, investing.

“Investors can rule out just about any company. We can customize these things as we talk to them. We build ESG profiles for every company we own,” says Tom Manning, CEO and president of F.L. Putnam Investment Management Co. He is based in Wellesley, Mass., but the company has a large presence in downtown Portland and a satellite office in Portsmouth, N.H. The company does about a third of its business in Maine, including managing ESG investments for the Maine Community Foundation. It has 500 clients and more than 100 institutions, churches, colleges and foundations throughout the United States.

Of the $1.4 billion F.L. Putnam manages, half is in ESG funds. The other half gives clients the opportunity to diversify more. The funds, he says, produce good returns over time. The company services pension funds and other high-wealth clients and institutions, but is looking for a platform for smaller investors. Currently, the typical investment minimum is $500,000 but it can top $100 million for its clients throughout the country.

Some $6.57 trillion went into sustainable and responsible investing, or SRI, at the end of 2014, up from $3.74 trillion in 2012, according to the Forum for Sustainable and Responsible Investment, also known as the US SIF Foundation. That's more than 76% growth. The largest chunk of that is ESG investing, which reached $6.2 trillion in 2014, up from $3.31 trillion in 2012.

Those are lofty increases from the “tree-hugger” green investments of the mid 1990s, when ESG investments were at $166 billion in 1995, but picked up steam in 2001 to $2.02 trillion and continued mostly on an unabated upswing since then, according to US SIF.

Boosting interest in ESGs are efforts by business leaders like Bill Gates, Mark Zuckerberg and Sir Richard Branson, who formed the Breakthrough Energy Coalition that they announced at the United Nations Climate Change Conference in Paris in December. The coalition is a multi-billion-dollar initiative to fund clean energy research and development. It involves businesses, entrepreneurs, universities, governments and investors from around the world, with funds awarded to the most promising clean technologies, IW Financial, an ESG research supplier also in Portland, notes on its website.

Also pushing the trend toward ESG investments are a number of factors, including millennial preferences for “clean” stocks, moves by companies to reduce their carbon use and waste, and international accords like the recent Paris climate agreement signed by 195 countries, and with pledges by thousands of companies worldwide to clean up their act. ESG investing helps hold them accountable.

Initially, social and environmental stocks typically were in mutual fund baskets available from mutual fund companies like Fidelity and Oppenheimer. Today, ESGs also take a more formal structure, with investors talking to institutional and other high-wealth customers about their preferences for ESG investing, then listing companies they choose for investment.

There is at least one big difference between SRI and ESG investing, according to F.L. Putnam. SRI is a good way to make sure an investor's portfolio aligns with their values. But ESG, which falls under new U.S. Department of Labor guidance released last October, adds a risk management tool to the mix. ESG investments, especially in volatile regions or in new energy technologies, can carry large risks that investors need to know about. F.L. Putnam says ESG is a quantitative approach that ranks all companies relative to industry peers on industry-specific key issues. It also focuses on longer-term strategic risks and how well companies are preparing to address them.

“ESGs gained steam in the last few years. There's more quantitative analysis now. And there's a sea change of disclosure on ESG documentation,” says Robertson Breed, senior vice president and portfolio manager at F.L. Putnam in Portland. “It's becoming more standardized.”

ESGs: Not just a fad

Some 73% of corporate decision-makers take ESG issues into account in their investment strategy, according to the CFA Institute. And studies from Deutsche Bank Group Climate Change Advisors and others have found sound returns for ESG portfolios. A 2012 study by Deutsche Bank, for example, found that incorporating ESG data in investment analysis correlated with superior risk-adjusted returns at a securities level.

A Harvard Business School study of 40 chief investment officers on corporate sustainability found that 5% believe a socially responsible investing fund outperforms a conventional mutual fund and 30% responded that they can better predict stock price performance when they analyze ESG data along with financial data.

So the results don't just come in the form of return-on-investment. The ESG companies themselves are monitored for conforming to their sustainability and other social plans. They must make data available and issue corporate responsibility reports.

For example, MSCI Inc., among many things, provides equity portfolio analysis tools. And there's a burgeoning $250 million sustainability information market with about 150 rating systems covering more than 50,000 corporations on about 10,000 performance metrics, according to the Global Sustainable Investment Alliance.

What's in a name?

F.L. Putnam breaks down ESG investing into three broad baskets to help investors choose what they do and don't want in their portfolio. The investment management company has a detailed questionnaire for its clients.

In the “E” or environmental part of ESG, investors are asked for their preferences on toxic emissions, carbon emissions, water stress, biodiversity and environmental opportunities such as a company's exposure to environmental improvement or management.

For the “S” or social portion of ESG, they can check off supply chain labor standards, sourcing from or selling into controversial regimes like Sudan or Iran, labor management, discrimination and workforce diversity, employee safety and health, social opportunities and product safety and quality.

For the “G” or governance portion of ESG, they can choose stocks based on independence and/or diversity of the board of directors, independence of key committees, ethics practices and shareholder rights practices.

Digging deeper into the weeds, clients can select whether or not they want a company with hydraulic fracturing exposure, one that produces or distributes alcoholic beverages, one that uses embryonic stem cells, has exposure to gambling, performs non-accredited animal testing, supports workforce diversity, uses alternative energy, embraces green building, uses sustainable agriculture and many, many more factors. It can even involve companies and universities examining whether to divest from fossil fuel stocks.

Manning adds that it's not always clear who the big toxic emitters are. “The biggest energy companies emit the largest amount of carbon,” he says, “but smaller companies may have more toxic emissions.” He says his company can help clients sort through the data to make the correct choice. The end result for the client is an investment policy statement.

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