US institutions ramp up ESG investing on evidence of stronger returns, finds Breckinridge

ESG investing

Institutional investors in the US are increasingly planning to adopt ESG in their portfolios, swayed by recent evidence of sustainable investments’ outperformance.

Investors in the US have so far lagged behind those in other parts of the world on sustainable investing, with only one third of US institutions currently using ESG in their portfolios, according to a survey by Breckinridge Capital Advisors and Greenwich Associates. Among the rest, two-thirds say they are actively considering adopting ESG or might do so in the future. 

Institutions’ reasons for adopting ESG investing are also shifting away from a desire to align investments with their values, and towards investment-based factors.

ESG strategies outperformed during market volatility last year, with research from BlackRock finding that 94 per cent of sustainable indices beat their benchmarks in the first quarter of 2020.

A separate study from asset manager Fidelity International reported that stocks with their highest ESG rating outperformed those with weaker ratings in almost every month from January to September.

More than one in five institutions in the study say their adoption of ESG was purely an investment-based decision, while about a quarter say their choice to adopt ESG was driven by a combination of values-based and investment-based factors.

In most cases, the decision to use ESG criteria came from the investment team itself, with 45 per cent saying the decision came from the board.

Breckinridge and Greenwich Associates surveyed 80 decision-makers at US institutions including corporate and public pension funds, endowments, and foundations with assets under management up to USD1 billion. 

Investment factors are also playing an ever-more central role for institutions that are considering adding ESG criteria. This group ranked enhancing returns and reducing risk as the two most important goals for ESG inclusion, with the desire to make positive impact ranking third.

In October, the US Department of Labor imposed new rules on pension funds that banned them from investing according to non-financial factors, making it harder for pensions to invest in ESG funds.

According to Breckinridge and Greenwich Associates’ survey, 30 per cent of the corporate pensions in the study say the ruling had a “meaningful impact” on their approach to ESG. One corporate pension executive explained that, from his perspective, the ruling “validates the belief that ESG should only be considered if it affects investment performance”.

The study says that investment grade fixed income may be an “ideal starting point” for institutions adopting ESG, because ESG analysis seeks to uncover financial risks and therefore “may make an investment grade fixed income portfolio more resilient”.

One-third of US institutions’ overall portfolios are allocated to fixed income, and the study found that investors' concerns are growing over the returns these substantial fixed income portfolios may generate, with upcoming fiscal stimulus and monetary invention by the Federal Reserve. 

Institutions are lagging significantly behind their target allocations toward investment grade fixed income, due to a prolonged period of stock market outperformance that inflated the valuation of equities. 

Investment grade fixed income accounted for 81 per cent of those institutions who currently use ESG compared to other asset allocations, topping even domestic equities at 73 per cent, followed by non-domestic equities at 69 per cent.

“Institutions believe that adding ESG criteria to an investment grade portfolio can enhance resiliency and possibly performance,” says Andrew McCollum, head of Investment Management at Greenwich Associates. “In addition, investment grade portfolios represent a logical and relatively seamless starting point for the integration of ESG into their broader organisations.”

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