As President of Parnassus Investments, I often think about what responsible investing might look like over the coming decades. The future is anchored in the past, so I believe the best way to begin an answer to this question is with a look back at the early years of responsible investing.
The Origins of Values-Based Investing
The modern movement to link investors’ values with their portfolio holdings is rooted in the 1970s. During this period, social concerns like the Vietnam War, civil rights, women’s equality and environmental protection became passionate causes for many members of the Baby Boomer generation. At this early stage of the movement, some idealists were willing to accept lower returns in exchange for investments that aligned with their views on social issues.
The key feature of these early responsible investment strategies was the application of screens to limit the investment universe. The idea was to avoid companies that were perceived as harmful to the environment and society. Many observers concluded that a limited universe would necessarily diminish returns over time. This notion that responsible investing would, by definition, under perform persisted for many years.
Parnassus Investments began with a different vision. The firm’s founder, Jerome L. Dodson, launched Parnassus in 1984 with the idea that a well-designed responsible investment strategy could outperform traditional investment strategies. Starting with this mission of delivering “Principles and Performance®,” Parnassus developed a process that evaluated both the financial merits and the environmental, social and governance (ESG) characteristics of each potential portfolio company. The result was an investment strategy designed to uphold shareholders’ values and to perform as well or better than non-ESG strategies over the long term.
Sustainability Joins the Mainstream
Thanks to vocal consumers, shareholders and responsible investment firms, a growing number of companies are now promoting their sustainability, workplace and other social achievements as essential aspects of their brands. At the same time, many corporate leaders have come to realize that pursuing social responsibility can reduce litigation and reputational risk, while also improving innovation and efficiency. In addition, recent academic studies have demonstrated that investing in companies with strong ESG profiles can improve portfolio returns.
In the context of these developments, it is not surprising that responsible investment strategies have grown dramatically. Morningstar now tracks more than 200 socially conscious mutual funds with combined total assets in excess of $100 billion. Many of the new offerings have been launched by large investment managers, who hadn’t traditionally been associated with the responsible investing movement. For example, Natixis, Eaton Vance and BlackRock have developed sustainable fund lineups over the past three years.
The Baby Boomers who grew up with the responsible investment movement now have more options than ever to align their investments with their values. Meanwhile, their children, the generation dubbed “millennials,” have demonstrated a keen interest in ESG investment options.
Expectations for Broader and Deeper ESG Influences
Given this backdrop, I expect two developments in responsible investing going forward:
• First, ESG research will be incorporated at some level into investment processes that aren’t primarily marketed as ESG solutions. This is because investment managers will recognize the performance advantages of companies with positive ESG profiles.
• Second, as traditional asset managers get comfortable with using ESG research, they will continue to look for ways to offer ESG versions of their traditional investment products. This is the natural response to the increased desire by shareholders to align their investments with their principles.
Both trends should increase the demand for even more ESG research from third-party providers. This research will likely come from traditional brokerage firms that already provide fundamental research, as well as from research firms that specialize in ESG analysis. Eventually, demand for ESG data should lead to more transparency and standardization of ESG metrics, expanding on the work that the Sustainability Accounting Standards Board (SASB) is already doing. In turn, corporate executives and board members will become even more savvy about ESG issues. These improvements in measurement and transparency should lead to better company and portfolio-level ESG performance over time.
Risks and Opportunities for Responsible Investment Managers
As ESG research becomes more widely available from third parties, responsible investment managers’ competitive advantages could potentially erode. However, I think portfolio managers who succeed at finding companies that continually raise the bar on corporate sustainability will be able to add value relative to their peers over time. And, in my experience, on-the-ground research—visiting companies and establishing relationships with management—is a critical aspect of developing this type of comprehensive view of portfolio holdings.
But getting to know company leaders is not enough. Advocating for the values we share with our clients through engagement with management is a natural evolution of the original concept of linking shareholders’ values with their investments. An ongoing exchange of ideas with management can develop a better understanding of how the company operates. It also provides insights into management’s sensitivity to ESG-related issues and the level of effectiveness of the board’s oversight.
Furthermore, as a relationship deepens over time, it is easier to address controversial events that may arise, discover what steps are already being taken to improve ESG performance and help management formulate additional remedies, if needed.
Building relationships that help companies improve their corporate social responsibility is good for all stakeholders. Because of this, a leader in the responsible investment industry must be willing and able to effectively engage with the management teams of portfolio companies on ESG issues.
Responsible Wealth-Building for the Long Term
In summary, I am confident that companies will benefit economically by pursuing excellence in corporate responsibility. This is especially true in the context of climate change and increased resource scarcity. As responsible investing integrates into the mainstream, I anticipate that ESG data will be incorporated into greater numbers and types of investment strategies. I believe that those investment firms that can successfully identify companies with leading ESG profiles, strong financials and attractive fundamentals will be the most likely to succeed. Finally, I think that leadership in the responsible investment industry will require meaningful engagement with portfolio companies on ESG issues.
Article by Benjamin E. Allen, President of Parnassus Investments and a portfolio manager for the Parnassus Core Equity Fund. Parnassus has offered socially responsible investments since 1984.
Mr. Allen joined Parnassus Investments in 2005 as a Senior Research Analyst and was previously a Parnassus research intern. In 2008, he was promoted to Director of Research and subsequently became Portfolio Manager of the Parnassus Core Equity Fund in 2012. Prior to joining the firm, Mr. Allen worked at Morgan Stanley in New York, first as an Investment Banking Analyst and later in the firm’s venture capital group. Raised in Massachusetts, he is an alumnus of the Boston Latin School. Mr. Allen graduated Phi Beta Kappa and magna cum laude from Georgetown University with a bachelor’s degree in government, and completed the general course in philosophy at the London School of Economics. Mr. Allen received his master’s degree in business administration from the University of California, Berkeley.