Wells Fargo Private Bank
Regional Chief Investment Officers

Kei Sasaki, CFA, Northeast
David Roda, CFA, Southeast
Cam Hinds, CFA, Great Lakes
Marc Doss, CFA, California
Michael Serio, CFA, Mt. Northwest
Sean McCarthy, CFA, Southwest

In this Monthly Market Advisor:

  • While the roots of Socially Responsible Investing ("SRI") date back centuries, this movement has only recently developed a widespread, global following among investors, which is accelerating.
  • Today such strategies encompass more than simply "responsibility" and have expanded their reach into "sustainability" and "impact," presenting investors with new complexities and potential opportunities.
  • Investors have tools for aligning their personal values with traditional investment objectives through the growing suite of noteworthy investment strategies.

Download the report (PDF)

One could argue that "purpose" is the key determinant of long-term future economic outcomes. Whether it is for profits or people, purpose is an idiosyncratic factor that has been somewhat arbitrary for investors, as its benefits have been difficult to quantify. Today, the vast pool of information, expertise, and technologies is rapidly making this formerly nebulous space more systematic. Socially Responsible Investing ("SRI"), Environmental, Social and Governance ("ESG") investing, Impact investing, and activism have all been prominent on the investment scene for some time. These "purpose-driven" disciplines are now moving further into the mainstream with the potential to transform the capital markets and affect generations of future investors.

While SRI might have been straightforward in the past, the definition is evolving. For example, the Forum for Sustainable and Responsible Investment (US SIF), refers to SRI as "sustainable, responsible, and impact investing," which arguably is broader in scope. At Wells Fargo, we refer to the discipline as Social Impact Investing (SII). For purposes of this paper, we will reference this broader representation. For investors with clear social and/or impact-related objectives, SII could be a key missing ingredient.

Origins, growth and key drivers

The roots of this discipline can be traced back as far back as biblical times, and during the 1700s the Methodists and Quakers were said to have introduced such concepts to the western world. The ranks of modern-day practitioners grew during the turbulent political climate of the 1960s and 1970s. Soon after, the base of SII investors grew rapidly across religious, academic, and sovereign establishments. As society advanced, implementation of this discipline became more sophisticated. Those implementing such strategies introduced processes that made it easier to apply more defined metrics such as those associated with ESG factor architectures, as seen in Figure 1.

Figure 1: ESG Factors and Considerations

Chart listing the factors and considerations associated with Environmental, Social, and Governance (ESG) investing discipline. Contact your Relationship Manager for more information. 

Source: Wells Fargo SII Group (formally Nelson Capital Management, LLC), April 2016

A recognized authority in this field is the United Nations Principles of Responsible Investing ("UNPRI"), established in 2005. It boasts over 1,500 signatory members that oversee a total of more than $60 trillion in assets.1 The 10-year annualized growth of 26 percent in signatory assets is a proof statement for the movement. Adoption has been primarily driven by overseas investors but is now rapidly gaining a following in the U.S. According to the UNPRI, only a fifth of its signatories are U.S.-based.2 According to Cerulli Associates, more than one out of every six dollars under professional management in the U.S. is invested in an SII strategy.3 Also, the US SIF states that from 2012 to 2014 related assets grew more than 76 percent, a clear sign of an acceleration of U.S. SRI adoption.

SRI's growth has been spurred by four key drivers. First, accessibility of information has vastly improved, allowing investors to draw from a much higher quality pool of information than before. Investment performance is better supported by quantitative metrics and academic studies that offer compelling evidence of how SII can support and enhance investment performance. As previously mentioned, the breadth of values of the investing public is expanding, and these values are becoming a more important consideration for companies and governments as capital flows shift in response. Finally, we have the rise of the Millennial generation, a generation widely viewed as being champions of purpose over profit based on a Millennials Survey conducted by Deloitte in 2016.4 Its increasing economic clout could extend SII acceleration as corporations and governments adapt to the growing influence of this generation.

The SII fragmentation challenge

While SII's growth is rapid, it is far from uniform. Many SII investors are not satisfied with standardized generic approaches, such as "negative screening" strategies, which simply exclude assets that are deemed non-SII or ESG compliant. Industry service providers have established exclusionary standards, which many asset managers reference to construct portfolios. While scalable and economically beneficial to an investment manager, the end product tends to fall short of the investors' core ideals−in other words, "buyer beware". As a result, some investors are accessing solutions through the private market, which tend to better mirror the lengthier time horizons it usually takes to realize the tangible benefits of SII, in our opinion.

Jane Ambachtsheer, Partner at Mercer Investments and Chair of Responsible Investment, had this interesting quote: "Responsible investment isn't about changing the world; it's about understanding how the world is changing and how companies will be affected."5

In this quote she addressed the critical dilemma of how investors may be able to bridge the gap between traditional investment objectives and personal values. She implies that the developments in SII have been a result, not the cause, of global shifts. Thus, in order for asset managers to address the fragmentation challenge, they must first acknowledge this reality and recognize the limitations of scalability in SII.

The SII report card: Assessing the results

Advancements in SII performance analytics have raised the bar for money managers and allowed new avenues for the enhancement of investment strategies. Studies have analyzed the relationship between corporate market-based performance and governance practices,6 and they revealed a positive correlation between higher SII ratings and fundamentals. Shareholder activism strategies have also shown evidence of positively contributing to fundamentals.7 Even some fixed income SII studies have shown that strong governance scores can lead to healthier credit ratings.8 Of course, past performance is no guarantee of future results.

While there is progress, challenges remain. Investors should seek out full transparency to avoid poorly managed SII strategies. Also, it is worth noting that current SII metrics are far from perfect. However, traditional stock and bond analytics also continue to evolve and so, the golden age of SII is likely still ahead.

Conclusion: Investor implications

In conclusion, the growing importance of SII could present new opportunities for investors who choose to invest based on their heart-felt principles. Also, the SII movement is triggering an evolution of corporate and sovereign practices. This may ultimately change how global capital will be invested and present new growth opportunities for investors in an otherwise growth-starved world. Investors should consider the breadth of available SII vehicles while recognizing that this is an emerging discipline. It is difficult for many investors to properly assess SII portfolio quality. Also, just like with any kind of wealth planning, investors should not let a single criterion overrun their portfolio. Therefore we recommend that SII investors engage a trusted investment advisor with access to strong SII resources to help identify quality SII strategies that align to their overall wealth plan.

1 http://annualreport.unpri.org/PRI_AR-2016.pdf, 2016 Annual Report

2 Principles for Responsible Investment, April 2, 2016

3 The US Forum for Sustainable Investing, April 2, 2016

4 2016 Deloitte Millennial Survey, Deloitte Touche Tohmatsu Limited (“DTT”), The DTT 2016 Millennial survey is based on 7,700 Millennials representing 29 countries around the globe. All participants were born after 1982, have obtained a college or university degree, are employed fulltime, and predominantly work in large (100+ employees), private sector organizations.

5 The Evolution of Responsible Investment, Mercer, June 2014

6 Deutsche Bank, Sustainable Investing — Establishing Long-Term Value and Performance, 2012.

Hermes. ESG investing: Does it just make you feel good, or is it actually good for your portfolio, 2014

GMI Ratings, GMI Ratings Research Findings: For the 10-year Period Ended August 31, 2012, a Portfolio of Companies with Top-decile AGR Ratings Would Have Outperformed the Lowest-decile Portfolio by 54%, 2012.

7 The Long-term Effects of Hedge Fund Activism, April 29 2014

8 Scientific World Journal, October 27, 2014, Effects of Corporate Social Responsibility and Governance on Its Credit Ratings, Dong-young Kim and Jeong Yeon Kim