March 26, 2013
Mega-sized endowments, pension funds and hedge funds have
the ability to move the markets and change investing trends. So when two of the
largest begin moving into a style or sector, itcan be fruitful for us regular
retail investors to pay attention.
In this case, two of
California’s largest pension funds (CalPERs & CalSTERs) have recently made
environmental, social and governance (ESG) issues a major theme to their
investment process. While ESG investing has been generally disappointing in the
returns department over the last decade or so, the pension fund's shift into
the portfolio style certainly could bring better prospects in the years ahead.
Overall, California’s decision could be the catalyst to make ESG investing more
main stream and profitable.
Billions of Social
Dollars
Combined, the
California Public Employees' Retirement System (CalPERs) and the California
State Teachers' Retirement System (CalSTERs) have nearly $413 billion under
management; so when they throw their combined weight around an idea, it usually
turns out to be a good one. This time the initiative is to incorporate
environmental, social and governance ideas into their investment processes.
ESG or social
responsible investing basically adds a “filter” to stock selection by only
choosing firms that meet certain social or environmental standards. These ESG
screens can include everything from resource management and pollution
prevention to labor and human rights issues. The basic idea is to only engage
in firms that have desirable social or ethical practices. By applying these
screens to their research, the two pension plans hope to achieve added returns
for their investors as well as change the world for the better.
There is some evidence that applying ESG metrics
after initial financial research does produce better returns. According to
Goldman Sachs, companies that are considered leaders in ESG policies are also
leading the pack in stock performance by an average of 25% over the long term.
This echoes similar research by RCM, which found that between 2006 and 2010,
investors could have added an additional 1.6% a year to their investment
returns by allocating to portfolios that invest in companies with above-average
ESG ratings.
However, CalPERs is
taking things a bit further aside from avoiding sin and weapons stocks. The
pension fund plans on shifting roughly $50 million a year, indefinitely, into a
concentrated portfolio. The focus of this is to buy shares of stocks that are
underperforming and directly benefit from CalPERs ESG influences. The role of
the portfolio is not to interfere with the running of the company, but to hold
the board accountable and for the board to oversee the management strategy.
Recent wins for the pension include shareholder resolutions to force governance
changes at Chesapeake Energy (NYSE:CHK) and driller Nabors (NYSE:NBR).
CalSTERs expects to
launch its own actively managed concentrated ESG portfolio by buying additional
stock of the companies it is engaging later this year.
How to Participate
Odds are the retail
average investor doesn’t have enough capital to directly influence the board of
a large corporation. However, there are ways to add a dose of ESG investing to
their portfolio.
The magazine Pension
& Investments highlights Adobe Systems (NASDAQ: ADBE) Staples (NASDAQ:
SPLS) and Steel Dynamics (NASDAQ: STLD) as CalPERs latest ESG targets. Betting
directly on them could prove prudent; however, a better way could be through an
ESG exchange traded (ETF) or mutual fund.
The iShares MSCI USA
ESG Select Index (NYSE: KLD) tracks U.S. large- and mid-cap stocks screened for
positive environmental, social and governance characteristics. Currently, KLD
holds 133 different firms and nearly $200 million in assets. The ETF could a
good starting place for investors looking to add ESG screens to their
portfolio.
Another solid choice
could be the Vanguard FTSE Social Index Investing mutual fund (VFTSX). The fund
focuses on similar ESG metrics like the iShares ETF, but charges a dirt cheap
0.29% expense ratio. The ESG metrics employed by the fund has allowed it to
slightly outperformed the S&P 500 over the past five years, generating roughly
6% annualized returns.
The Bottom Line
With two of the
country’s largest pension funds moving into the world of ESG investing, regular
retail investors may want to get in on the act. While the lack the size and
scope of CalPERs and CalSTERs, there are plenty of ways to add social and
environment values to their portfolio. That could be a good thing in the return
department as well.
by Aaron Levitt
Aaron Levitt is an
independent investment writer and analyst living in State College,
Pennsylvania. His work appears in several high profile publications in both
print and on the web. Levitt is an advocate for long term investing with a
global framework. You can follow his picks and pans at
http://twitter.com/AaronLevitt
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