By Kevin McNabola
Orange Board of FInance
Are environmental, social and governance investments the new investment strategy going forward?
There is growing evidence and real data indicating that nearly two thirds of all endowments and pension investment portfolios will include ESG within the next decade. Here in Connecticut and across many regions of the US we have seen a significant increase within ESG investments, particularly within college and university endowments and state pension funds.
Connecticut, along with Rhode Island, Massachusetts, New York and New Jersey, has taken significant steps to invest in companies and portfolios that have adopted ESG principals. The state treasurer has committed Connecticut’s $43 billion pension fund over the past four years to including many new investment partners with investments heavily weighed on ESG and away from the traditional fossil fuel investments. Treasurer Shawn Wooden has been confident that ESG investments will ultimately outperform the conventional investments.
It is important to understand that the treasurer does assess ESG matters together with weighing the financial criteria when making investments decisions within the pension portfolio, including weighing those companies that promote sustainable business practices and promote diversity on corporate boards. This is done so that there is a real potential to deliver value to the stakeholders consistent with the fiduciary obligations to act in the best interests of investors and maximize returns. However, the grim economic climate of 2022 featuring rising interest rates, volatile markets and persistently high inflation will make it difficult for both university endowments and state pension portfolios to generate healthy returns regardless of ESG investments.
Many CEOs of publicly traded companies, such as General Electric, Starbucks and Pepsi, are advocates of the ESG metrics. Many corporate executives feel that taking steps to improve labor conditions, enhance the diversity of their corporate teams, give back to their communities and take a stand on sustainable environmental policies strengthen their companies’ brands. As millennials become employees, consumers and investors, they take note of good corporate actors and reward them with loyalty.
Many US-based companies are taking proactive stances to incorporate best practices as part of ESG issues. It is important to adhere to some best practices for benchmarking and strengthening the company’s ESG program.
As a former corporate executive at General Electric, I believe the best approach would be for companies to identify the appropriate ESG criteria for both their industry and company. When developing an ESG policy framework, companies should not try to be all things to all people. Rather, identify three to five measurable ESG criteria that are material to the business and constituency, but most importantly aligned with the corporate strategy.
I would also recommend to asset managers and investors not to totally divest oil and gas or other fossil fuel investments, since it has been the bedrock of the US economy for decades. A diversified portfolio is always the way to go.
I hope to follow up on this subject in the coming months and present an analysis in the near future to benchmark some of the state pension portfolios, university endowments and US-based corporations to see whether ESG investments outperformed the traditional portfolios of those institutions that did not invest heavily within ESG.
Kevin McNabola is the chief financial officer for the city of Meriden and a member of the Orange Board of Finance.