Environmental, social and governance (ESG) investing is an important ingredient in delivering returns that have the potential to beat benchmarks, according to Morgan Stanley’s $500+ billion global asset manager.

The sustainable investing landscape is fast evolving. Driven by global asset owners, especially in Europe and Japan, as well as U.S. endowments, foundations and pension funds, investor interest has reached an all-time high and fund managers are increasingly evaluating how environmental, social and governance (ESG) issues impact their ability to deliver returns that have the potential to beat benchmarks.

Morgan Stanley Investment Management, which actively invests $507 billion across public and private markets, views the incorporation of ESG analysis as an important part of analyzing risk and opportunity across its investments, according to Dan Simkowitz, Morgan Stanley’s Head of Investment Management.

“In Investment Management’s strategies—across equities, fixed income, private equity and beyond—evaluating ESG factors is essential,” Simkowitz says. 

Simkowitz recently led a discussion about the ESG edge in long-term investing at Morgan Stanley’s inaugural Sustainable Investing Summit, where he was joined by Pontus Bergekrans, Group Chief Investment Officer of Life & Pensions at Stockholm-based Skandinaviska Enskilda Banken AB (SEB), Morgan Stanley Investment Management’s Vice Chairman Ted Eliopoulos and Managing Director Seema Hingorani.

The Summit was hosted in New York by the firm’s Institute for Sustainable Investing, which has collaborated with clients and institutions to mobilize capital to sustainable enterprises since 2013. Capitalizing on the momentum of current demand, the Summit gathered industry leaders—company executives, institutional investors and academics—to share their ideas and insights around innovation in sustainable finance.

While fund managers are quickly realizing the benefits of incorporating ESG factors, many are still thinking through how to best integrate them.

Sustainable Investing Frameworks

While fund managers are quickly realizing the benefits of incorporating ESG factors into their investment strategies, many are still thinking through how to best integrate them into portfolio management, according to Eliopoulos.

“Investors need to identify their frameworks,” he says. “That means answering some key questions: What data do we need? How will we integrate ESG considerations? How will we work with fellow investors to engage with corporations?”

In 2017, Morgan Stanley Investment Management formed its Sustainability Council, which includes portfolio managers and ESG leaders from across the division and the firm’s Institute for Sustainable Investing. The Council seeks to ensure sharing of innovative approaches and best ideas across teams and to develop an overall ESG framework. Within that schema, individual investment teams are encouraged to align with specific approaches that best suit the strategies they manage.  They include:

  • Restriction screening: Avoiding investments in certain sectors or issuers based on values or risk criteria
  • ESG consideration: Including ESG criteria as part of the investment process, with the main goal of limiting exposure to ESG-related risks
  • ESG integration: Using ESG criteria alongside financial analysis to identify opportunities and risks
  • Thematic investments: Investing in themes and sectors positioned to solve global sustainability-related challenges
  • Impact investing: Allocating to funds or enterprises intentionally structured to deliver a specific and measurable set of positive social or environmental impacts

ESG Investing and Company Engagement

Across its various teams’ ESG approaches, Morgan Stanley Investment Management focuses on direct communication with companies on a variety of sustainability topics. Key areas of focus include climate change, recycling, energy efficiency, water management, sustainable packaging, the opioid epidemic, workforce diversity and executive compensation.

“We don’t outsource proxy voting or engagement with companies,” Simkowitz says. “ESG engagement across strategies is a hallmark of our business, and we’ve seen appreciation from asset owners that’s really special.”

Direct engagement is an approach embraced across asset classes, including those that have traditionally been more passive in nature, historically. For example, the Global Fixed Income team, which manages $68 billion, proactively asks companies in which they’re bondholders about relevant ESG issues, such as climate risks for property and casualty insurers or drug pricing responsibilities for health care manufacturers. While equity shareholders with voting rights have historically led direct engagement with companies about ESG risks and opportunities, Investment Management is empowering managers and analysts in all asset classes to be sustainability stewards driving conversations with management teams. 

Alongside reducing the carbon footprint of their portfolios, institutional investors are also focused on supporting gender diversity.

Key ESG Issues

Alongside reducing the carbon footprint of their portfolios, institutional investors are also focused on supporting gender diversity, according to the Summit panelists.

Hingorani says investors and firms are increasingly prioritizing hiring women, not only to close the gender gap but because they believe diversity has the potential to lead to better financial performance.

“We hear a lot more institutional investors saying this: If you don’t have diversity on your investment team, I don’t know if you’re going to consistently outperform over time,” she says.

Hingorani founded Girls Who Invest, a 10-week on-campus summer program that also includes online programs and prepares college women from diverse ethnic and socio-economic backgrounds, universities and majors for investing careers. One mission of the program is to increase women’s share of the approximately $100 trillion of professionally-managed global capital—to 30%, up from current levels of less than 5%, she says.

In short: Fund managers and institutional investors are increasingly considering investments in companies and assets through the lens of environmental and social sustainability in their search for alpha, according to the Summit panelists. Identifying standardized data and frameworks and directly engaging with companies about the most important challenges of our time are essential in capturing the potential to outperform in the ever-evolving landscape of sustainable investing.