Ready Or Not, The Second Age Of ESG Investing Is Here

With this new consensus around giving attention to ESG considerations upon us, success will require specialized knowledge, forward thinking and a long time horizon.

Success in the second age of ESG investing isn’t going to be easy. The road to achieving your outcomes is probably going to be longer and harder than ever before.

But we believe that with the right strategic partner and the right actively managed strategy, it can be traversed successfully.

Khanchit Khirisutchalual/iStock via Getty Images Anyone who thinks markets are not paying attention to ESG is kidding themselves.

Case-in-point: While you may not have made a single move to reduce the carbon footprint of your portfolio, it’s probably already been significantly decarbonized—whether you like it or not.

A quick look at the composition of the S&P 500®Index illustrates this well. According to The Washington Post, oil and gas companies today make up just over 2% of the U.S. equity benchmark—a far cry from their 15% weighting in the index only 12 years earlier. 1 Even more telling evidence of this shift is found in the chart below, which shows that investors in both the S&P 500 and the MSCI World Index have seen the weighted average carbon intensity of their portfolios cut in half since 2009. Source: MSCI World Index, S&P 500 Index

This persistent, dramatic plunge is reflective of the fact that, despite recent rises in spot oil prices driven by the economic recovery and some supply squeezes, investors are expecting long-run diminishing returns on these companies’ future output. 2 In effect, they are discounting a global decline in the demand for oil that may take years to materialize but which long-term investors would be foolish to ignore. This has been driven by the increasing alarm around climate change and a resulting clamor for alternative energy sources as ESG-conscious governments, investors and activists make an increasing impact on corporate decision-making and investor expectations. In our view, this widespread recognition of the need to transition to a clean-energy economy, coupled with the heightened scrutiny on the social and governance practices of corporations worldwide, means that the first stage of ESG investing has come to a close.

Why? In a nutshell, many important ESG-related matters previously seen as non-financial in nature have shifted from being distant concerns with unknowable impacts to urgent problems that occupy center stage for businesses across the globe. In the first age of ESG investing, until a decade or so ago, accounting for the sunsetting of fossil fuels in the global economy, for example, seemed aggressive.

Although many were calling for it, the market had yet to accept it as a high-probability event, and it was certainly not seen as inevitable. These views are widely accepted first principles today.

This is how emergent ESG considerations enter the mainstream, gradually gaining ground until a tipping point is reached and a new consensus is baked into investment expectations. A second, more challenging era for ESG investors dawns

As these transitions from under-appreciated to fully priced-in occur, some lessons for the next stage of ESG investing are emerging. For institutional investors in this second age of responsible investing, the pathway to generating superior, risk-adjusted returns under an ESG lens will be through the ability to identify themes, handicap their likely trajectory and successfully map the impacts to asset class, sector, industry and company dynamics. No one needs to wonder anymore whether these broad phenomena, many exogenous to the financial system, can have a powerful impact on financial assets. The focus will inevitably turn from the macro to the micro, away from will things change ? to how will that change impact society?

At the start of the last decade, it wasn’t all that difficult to identify corporations whose stock prices would be impacted by a large scale transition to alternative energy sources. Large oil companies, for example, stood out easily—especially in the wake of the Deepwater Horizon disaster . In a similar vein, businesses with poor track records on social and governance issues could be flagged relatively easily by ESG-aware investors—and many remained unrepentant. But that’s changed dramatically in recent years, with ESG matters becoming front and center in corporate boardrooms worldwide. Now, the same oil-and-gas behemoths that made for easy targets 10 years ago have doubled down on their investments in alternative fuels—in some cases, becoming significant investors in green energy. 3 Traditional mining companies, such as BHP, are now some of the largest investors in rare-earth metals that enable clean technology. Meanwhile, many of […]

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