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What is ESG broadly speaking, and how does it compare with SRI?
Environmental, Social, and Governance (ESG) investing is a term frequently interchanged with other values based investing terms, including socially responsible investing (SRI), impact investing, sustainable investing, and screening.1 In reality, each of those represent slightly different investment approaches, but they share a common thread – namely, that prudent investing can be about more than just maximizing profitability and returns in the short-run. They all place an emphasis on not just “doing well” (attractive risk-adjusted returns) but also on “doing good” (supporting sustainable outcomes). The graphic below illustrates some of the more common breakout components for the environment, social, and governance factors.
Values Based Investing, which includes ESG and SRI, has been a rapidly growing part of the investment landscape in recent decades. In 1995,there was an estimated $639bn of assets invested in sustainable and responsible investments, which then grew to $35.3tn by 2020.3 That figure is likely larger today.
What about ESG resonates with Sapient?
Since Sapient’s inception, our investment philosophy and approach have been characterized by a long-term perspective that places risk management at the forefront. In this light, we believe ESG-related issues fall among the many important risk factors to be weighed and considered heavily by the investment managers with whom we partner. With few exceptions, the investment managers we engage with have actively managed, low turnover portfolios. They only invest in companies they’ve thoroughly researched, and they hold those securities for longer periods of time than most of their peers. Some also choose to engage directly with the management teams of portfolio companies, and we believe it’s prudent to also assess ESG risk factors as part of their investment process.
We engage periodically with each investment manager in our approved lineup to clearly understand how ESG is specifically integrated into their process. While it varies from one manager to the next – with some utilizing outside ESG ratings agencies for data and others not – there is a consistency of belief across our lineup of managers that how well they assess and manage ESG risks is important and will ultimately improve their odds of achieving attractive long-term investment performance. In other words, for the managers we partner with, ESG is structurally integrated into their processes rather than “bolted on” after the fact. Most have also been running their strategies far too long to consider rebranding as an “ESG fund,” but we don’t believe their lack of ESG branding is in any way a lower level of commitment to it.
What does ESG mean at Sapient?
At Sapient we are more philosophically aligned with the origins of ESG investing than its recent iterations. The term “ESG” can be traced back to at least the mid-2000s. A British law firm, Freshfields Bruckhaus Deringer, argued at the UN Environment Programme Finance Initiative that “incorporating ESG data would help protect investments by avoiding material financial risks from things such as climate change, worker disputes, and human rights issues in supply chains; and poor corporate governance and resulting litigation.”1 We believe this to be as true today as it was then, and it captures how we think about ESG at Sapient. However, more recent approaches to ESG investing have led to an exponential growth in the number Wall Street strategies branded as ESG,4 often buying the same companies en masse based on guidance provided by third party ESG ratings companies, leading to something akin to an ESG asset “bubble” during the past several years along with regulatory scrutiny about “greenwashing.”5 The influence of the leading ESG ratings agencies – firms like Sustainalytics and MSCI – has grown beyond levels we believe are healthy for markets, and their sometimes-wide divergence of ESG scoring for the same company across platforms highlights the still-nascent nature of ESG investing criteria. While many other investment firms have adopted this more formulaic approach to ESG investing, Sapient has not. We chose a different path.
How can Sapient integrate ESG/SRI into client portfolios?
At Sapient, we’re able to provide two approaches to sustainable investing – ESG and SRI. The former provides an awareness of and sensitivity to environmental, social, and governance factors within client portfolios through the approach described above; the latter provides the ability to screen out companies or industries that aren’t aligned with a client’s personal beliefs.6 Some clients choose to combine both approaches, which we are also able to accommodate.
Conclusion
In line with our fiduciary duty, Sapient constructs all client portfolios with a long-term perspective and an eye on risk management. Our approach allows for the adoption of ESG, SRI, or both, for clients seeking to take this extra step and integrate more of their personal values into their portfolios.
Sources:
1. The Washington Post, A Basic Guide to ESG Investing and Why it Faces a Backlash: QuickTake, June 30, 2022
2. Forbes, ESG Investing is ‘Soaring.’ What does it mean?, Nov 18, 2022
https://www.forbes.com/sites/joanmichelson2/2022/11/18/esg-investing-is-soaring-what-does-it-mean/?sh=21970c7751bc
3. Forbes, ESG In Asset Management: Breaking The Glass Ceiling, Nov 7, 2022
4. MSCI, Exploring 30 Years of ESG Indexes, 2020
https://www.msci.com/esg/30-years-of-esg
5. PGIM Quantitative Solutions, Navigating the ESG Bubble: The Deal with Data, August 15, 2022
https://www.pgimquantitativesolutions.com/article/navigating-esg-bubble-deal-data
6. Forbes, Socially Responsible Investing (SRI), May 24, 2023
Although the statements of fact and data in this report have been obtained from, and are based upon, sources that the firm believes to be reliable, we do not guarantee their accuracy, and any such information may be incomplete or condensed. All opinions included in this report constitutes the Firm’s judgment as of the date of this report and are subject to change without notice. This report is for informational purposes only and is not intended as an offer or solicitation with respect to the purchase or sale of any security. Past performance is not a guarantee of future results. Indexes, such as the S&P 500 Index, are not directly investable.
