We always try to write about environmental, social, and governance (ESG)-related topics in a way that is informative, engaging, and understandable for everyone who may be interested in the subject. Nonetheless, we expect institutional investors, wealth managers, and corporate executives to be more comfortable in this arena than most individual investors. After all, wrapping your arms around ESG and how it affects both the way companies pursue profits for their shareholders and investment strategies is not always easy. And let’s not forget that the ESG regulatory landscape is rapidly evolving and the terminology can be confusing.
The fact is, individual investors do care about ESG and sustainability, even if “experts” often fail to communicate in a way that meets those investors’ needs. How do we know this is the case? We looked at the evidence, which we summarize here, and then point out something we think is often overlooked (scroll to the bottom now, if you must).
Academic research says individual investors are rational about ESG.
To start, we summarize the conclusions reached in a recent study co-authored by academics at Stanford University, the Yale School of Management, and the Wharton School. They found that news about ESG-related issues appears to be an important part of at least some retail investors’ portfolio allocation decisions, as trading done by retail investors increased by over eight percent on days when major ESG news was made public. Importantly, these investors only made trade decisions based on ESG news when they viewed it as financially material. Interestingly, news related to “Leadership and Governance”’ had the largest impact on trading activity.
Key takeaways: (1) retail investors recognize that news related to firms’ ESG-related activities can be financially material and affect stock performance, and (2) on balance, individual investors react rationally, not emotionally, to ESG information. The study’s authors note that this latter point is relevant to policy debates aimed at asset managers who invest on behalf of retail investors (in pension funds and 401(k) plans). Several states have banned or are considering banning the use of ESG-related investment considerations in pension funds. This study shows that such bans appear to be inconsistent with how individual investors make decisions for their personal investment accounts.
Individuals need more education about ESG investing.
Looking for more evidence about whether retail investors think it’s a good idea to include ESG considerations in investment decisions, we found an insightful article titled Six Things to Know about ESG and Retail Investors. This analysis from FINRA (the Financial Industry Regulatory Authority) and NORC, an independent research institution at the University of Chicago, revealed that most retail investors still lack sufficient knowledge about ESG and how it can affect stocks and investing, but they are not rejecting the idea – quite the opposite. Here is a summary of their survey’s six key findings:
#1. Most retail investors believe investing is a way to make positive change in the world.
Retail investors are generally open to socially responsible or environmentally sustainable investing. More than half (57 percent) strongly or somewhat agree that investing can be a way to make positive change in the world; only 37 percent agree or strongly agree that a company should focus on maximizing earnings and should not pursue social or environmental goals. When asked whether investing can be a way to make a positive change in the world, only six percent of women disagree, compared to 11 percent of men.
#2. Most retail investors are unfamiliar with ESG investing.
Despite increased media coverage in recent years, only 28 percent of those surveyed report being at all familiar with ESG investing! Only 24 percent could correctly define ESG investing (we think that’s easier said than done), and only 21 percent know what the letters in ESG stand for. Familiarity was highest among investors under age 30 (but still only 37 percent), investors who earn less than $30,000 (40 percent – that seems high but may include college students who earn little, if anything but may be more ESG-aware), and Black investors (44 percent). Only 23 percent of women said they are at all familiar with ESG, compared to 33 percent of men.
#3. Fewer than ten percent of retail investors say they own ESG-focused investments in their taxable investment accounts.
Only nine percent of respondents said they hold ESG investments, while over a third of those with taxable brokerage accounts do not know whether their portfolio includes ESG investments. White investors are less likely to hold ESG investments than investors of other races/ethnicities (8 percent versus 12 percent). While some of these demographic differences may be related to varying levels of familiarity with ESG, the patterns persist when the study authors looked at differences just among those who said they are familiar with ESG investing.
#4. Environmental issues are not the only motivation for ESG investors.
For all retail investors in our sample (whether they hold ESG investments or not), financial factors (i.e., investment returns, fees, risk and tax matters) are most important when making investment decisions. Somewhat surprisingly, retail investors said that environmental aspects are least important when making investment decisions compared to social, governance and financial considerations. However, comparing responses from those who participate in ESG investing in some way to non-ESG investors shows that environmental factors are much more important to those who are already involved in ESG investing.
Over half of the ESG investors said they want to support companies that are environmentally sustainable. Other reasons for owning ESG include the belief that ESG investments will perform well financially (48 percent) and the desire to support socially responsible corporations (42 percent). Furthermore, the E, S, and G pillars appear to be equally important to this sub-group (ESG investors). In contrast, non-ESG investors say governance is most important.
#5. Most retail investors believe ESG investments will perform as well as or better than the market as a whole.
The argument that retail investors do not hold ESG-focused investments due to concerns about financial performance does not appear to hold up. Only 27 percent of those surveyed believe that companies that prioritize their impact on the environment and society will generate lower returns compared to the rest of the market. The largest group (41 percent) believe returns for such companies will not differ from the rest of the market, while 14 percent expect companies that include ESG considerations in managing the business will do better than the market.
#6. Most non-ESG investors don’t hold ESG investments because they haven’t thought about it or don’t know how.
Despite media coverage and the growing number of ESG investment products, many retail investors do not consider environmental, social or governance issues when making investment decisions. When asked why, the most common response was a lack of familiarity or knowledge! Almost half of respondents (46 percent) indicate that it never occurred to them to select ESG type of investments, 31 percent said they don’t know how to select investments of this type, and 28 percent say they don’t know how to determine if an investment is ESG. Only 15 percent cite performance concerns as a reason for not holding ESG investments.
Conclusions: Emerging attitudes about ESG investing appear to be driven in significant part by younger generations and non-white investors. As the investing population grows more diverse and younger Americans increase their investment portfolios over time, this appears to be an opportunity for the asset management and wealth management industries to do a better job of educating these groups and showing them the value of ESG investing.
Beliefs about ESG drive investor behaviors.
Lastly, an article from the Harvard Law School Forum on Corporate Governance on ESG beliefs and investors’ portfolios points out that ESG beliefs are important in making allocations to ESG investments. In fact, some morally motivated investors hold ESG investments even when they expect negative excess returns. ESG holdings are largest among investors with ethical ESG motives and substantial concerns about climate change. Roughly half of investors surveyed who hold ESG assets said they are primarily motivated by ethical considerations, while 80 percent of those who allocate to ESG investments report a high level of concern about climate risk.
What’s missing from all of these studies and surveys? The concept of ESG integration. They all assume that ESG investing means buying a fund that is identified as an “ESG” or “green” or “sustainable” fund. But that’s not the only way. Integrating ESG factors as part of a fundamental investment analysis is favored by many institutional investors, and a number of actively managed mutual funds are adopting this approach. It’s all about looking for companies that are reducing risks and increasing opportunities by looking at ESG issues in their industries. Contact us to find out how OWL ESG’s data can help you to explain the value of ESG to retail investors.