ESG’s Failed U.S. Invasion

It’s de rigueur in Europe to invest sustainably. But in North America such thinking — like warm ale — just hasn’t taken off.

Illustration by Ben Jones

Illustration by Ben Jones

“You like tomato and I like tomahto” is perhaps one of the best-known lines from Gershwin’s “Let’s Call the Whole Thing Off.”

The song, written back in 1937 for the movie Shall We Dance, takes on the differences between North American accents and British accents. Since then, Brits and their cross-Atlantic cousins are working ever closer in business, but even jet travel and multi-nationals haven’t yet erased some stark distinctions.

While American investors say they like “tomato,” Europeans say, “I like tomahtoes, provided they’re grown sustainably, harvested by workers paid a living wage, and transported without undue fossil fuel expenditure.”

Environmental, social, and governance (ESG) factors play significant roles in the investment decisions of nearly half (45 percent) of European institutional investors, a Royal Bank of Canada survey found in October 2017. Among American investors, just 12 percent consider ESG meaningful, as do 16 percent of investors in Canada. The same survey found that 40 percent of Europeans believe ESG-oriented investments would likely outperform non-ESG assets, whereas only 5 percent of U.S. investors say the same.

This chasm is both cultural and legislative, according to asset managers.

My-Linh Ngo, head of ESG investment risk at BlueBay Asset Management in London, says ESG strategies in North America used to be seen as tools to “do the right thing.” Some institutional investors treated the concept with suspicion, assuming that an ethical tilt to a portfolio meant sacrificing returns. “There was an ESG movement in the retail space and it had quite an ethical focus,” she explains. “This put some institutional investors off.”

More recently, products focused on risk management have developed in the North American institutional market, according to Ngo, who calls climate change a prime example of U.S. investor action.

In New York City, for instance, Mayor Bill de Blasio announced at the start of the year that the city had started looking at ways to divest its $189 billion pension system from fossil fuel interests within five years.

“The U.S. private sector is really stepping up on climate change, and where the U.S. presidency has lagged in leadership, the states, cities, and private sector have come forward,” Ngo explains. “It’s pure market economics.”

European financial regulators have also been far more forceful on ESG matters than U.S. rule makers.

In fact, U.S. legislation previously urged investors to focus exclusively on the bottom line. Attention to “any factors besides the bottom line,” including ESG, might have been seen as a “violation” of fiduciary responsibility, a recent Goldman Sachs Asset Management paper noted.

But things are changing.

In October 2015, the U.S. Department of Labor issued new guidance to plans covered by ERISA (the Employee Retirement Income Security Act), making clear that ESG considerations are A-OK to optimize risk-return decisions or break a tie between otherwise equal investments. BlueBay’s Ngo says that historic regulations in the U.S. have “been a constraint on investors... They were concerned that if they looked at these, they might get into trouble,” she said. “That changed a bit in 2015, when the new guidance was put out.”

Looking ahead, there is evidence that suspicion of ESG approaches may be dissipating among North American investors. Sustainable investing is on the rise, globally.

British fund group Schroders polled 22,000 investors across 30 countries last year, and 81 percent of American investors called sustainability more important to them now than five years ago. Among Europeans, 75 percent said so. Furthermore, 70 percent of Americans had increased their sustainable investments in the past five years, compared to 58 percent of Europeans.

Andy Howard, Schroders’ head of sustainable research, says that ESG factors are better recognized in Europe than in the U.S., but the trend is rapidly changing. “What you have in the U.S. is a higher level of variation,” Howard explains. “Some organizations are very advanced in how they think about ESG and some haven’t thought about it at all. It is not a philosophical resistance; it just hasn’t yet appeared on their radar screens.”