Are ESG tilts consistent with value creation in Europe?

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Yes! Some investors are keen to incorporate environmental, social and governance (ESG) factors in their portfolios.

However, others think ESG has little to do with value creation and investment returns. So, are active investment managers actually positioning their portfolios to back ESG factors? And can these ESG tilts be consistent with good performance? Whilst the data varies from region to region, overall we can answer those questions emphatically, in the affirmative.

Recent research by my colleagues shows that active managers in Russell’s European universes exhibit high ESG scores that are consistent with the relatively high scores for the European market, with a (small) majority of managers showing positive ESG tilts. This research should be seen in the context of our research across global markets which I wrote about last year.

We find that average ESG factor scores for both market indices and manager portfolios have grown significantly over the last three years. Also, there are regional differences in ESG scores, for both markets and active manager portfolios. The data confirms our global business experience. Europe is a leader (with Australia) in the incorporation of ESG factors into the investment process. Russell has observed a clear increase in resources dedicated to ESG by the community of European equity managers over recent years.

Other findings of note include the rise in importance of the Environment in Europe. Whilst Governance has been important to investors in most regions for many years, the Environment has now risen to be of equal importance in Europe, in terms of ESG scores.

The good news for investors who may be concerned that ESG tilting is in some way value-eroding is that active managers, selecting securities to add value relative to a benchmark, do not seem to think so. There are still some investors who can find it challenging to separate ESG integration, as a risk management and/or return seeking process, from Socially Responsible Investment (SRI) where there will often be objectives beyond simply financial return. We hope this research will help inform discussion of that issue, and help to clarify the distinction.

Last year’s (UK) Law Commission report “Fiduciary Duties of Investment Intermediaries” is also helpful. The report clarifies that, in seeking to generate risk-adjusted returns, pension fund trustees should take into account factors which are financially material to the performance of an investment and that may include environmental, social and governance factors.
There is still much to learn about ESG exposures, and the pricing of ESG risks over time. But with plenty of investor initiatives underway around responsible investment, and the PRI in Person annual conference taking place in London later this year, I am confident that 2015 will be another year of progress for investors in this area.

Mike Clark – Director, Responsible Investment

Russell Investments Wire - Mike Clark

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