Market Infrastructure Built Over the Past Three Decades Will Help Fuel the Next 30 Years

(Above: Getty Images, Courtesy of Calvert)

As we look forward to the next 30 years, we believe that capital markets are on the precipice of an increase in the impact of corporate environmental, social and governance (ESG) performance on security prices. We expect a corresponding acceleration of capital deployed to solve the environmental challenges we face today, such as excessive greenhouse gas (GHG) emissions and plastic pollution. We also expect substantial improvement in corporate diversity, equity and inclusion performance. At this moment, with war in Ukraine, the pandemic still raging globally and inflation hurting the poor the hardest, it may seem hard to accept an optimistic outlook for the future. However, with independent innovators like GreenMoney and Calvert laying the groundwork for the past few decades, we are now seeing the infrastructure that responsible investors like us have built having a real impact on transparency and capital flows.

GreenMoney has been and is a critical part of that market infrastructure, providing information about responsible investing, advocating for positive change, connecting investors and working to drive real-world improvement for all people. Over the entire 30 years of innovation and leadership by GreenMoney, Calvert has been there too, proudly.

Congratulations on the impact GreenMoney has had, and thank you for letting Calvert be part of it as we acknowledge our own anniversary of Calvert’s first socially responsible strategy 40 years ago this year.

Let’s take a look at the market infrastructure that has been built during this period to better understand our view of the future. As long-term responsible investors, we are interested in understanding the externalities a company creates in the course of its business. However, because externalities are generally negative impacts that a company has on the environment or on people directly, and that the company often hopes to avoid having to pay for or be penalized for, they are not eager to disclose information about the specific details of these externalities. Carbon emissions, human rights violations, pollution, weak performance on diversity and unsafe products are among the innumerable other adverse impacts companies have and for which they would prefer not to be held responsible. The market infrastructure necessary to create transparency into these issues, with sufficient detail to be able to use the information in investment decisions by every single investor, is what has been built or is in the final stages of development.

Markets are in the final stage of development of a regulatory framework across markets in the U.S., EU and U.K. that will increase the amount and quality of information about externalities related to carbon and methane emissions. This is on top of various requirements already in force in many major Asian nations, including China, mandating listed company disclosure of GHG emissions. In many markets, new or proposed regulations will require companies to provide additional human capital management and diversity information. Government regulations that require companies to disclose their performance on material environmental factors related to climate change will allow investors to better quantify and price these externalities, which is the market mechanism that sends signals to innovators and entrepreneurs about opportunities to develop new products and strategies that solve the problems caused by the corporate externality.

It is the transparency that these regulations call for that will help to accelerate the changes we need to solve the environmental and social challenges of today. Governments are also attempting to create market signals to speed capital deployment to solve climate and environmental problems. For instance, the United States is in the process of passing its very first climate legislation, which uses incentives to spur investment into renewable energy. California recently passed legislation that requires plastics to be recyclable and that also charges companies that use large amounts of plastic packaging a fee, which will be used to offset costs the state incurs in cleaning up plastic waste.

After decades of work, we now see a coordinated effort to strengthen market function through greater transparency, investors are increasingly using this information in the security price discovery process and government action to incentivize investment into solutions. We have already seen the development of new industries (renewable energy, electric vehicles) and companies, prior to this infrastructure and government action. We now expect to see an increase in capital formation and a real acceleration in real-world solutions.

For different reasons, but through similar mechanisms of information flow and transparency, we also expect acceleration in the improvements in diversity, equity and inclusion at corporations. The percentage of the highly skilled labor force made up of women and minorities is increasing worldwide. Companies are lagging in their ability to attract and retain women and minorities in their own employee ranks, and this is a material missed opportunity that companies are attempting to address. As we gain greater transparency into the demographics of individual companies, we find that virtually all companies know and want to improve, but struggle to do so. As more investors understand the opportunities that come along with better performance for all employees, shareholders are taking action to encourage companies to improve board and C-suite diversity. Companies are responding, and positive change is happening.

One question we often get about the future of ESG investing is, “If everyone uses ESG information, will there be any difference between mainstream and socially responsible investing?’’ The differences are very likely to be the same differences we see between mainstream investors and responsible investors today. There have always been independent thinkers and actors, innovators and change agents, and there has always been a mainstream herd following. Yes, almost all investors will consider ESG information in investment decisions, and this will make a difference to real-world outcomes. However, clients have always understood intentionality. There are those driving for positive change versus those clinging to status quo and protecting entrenched interests and power. That won’t change, and that is why we need another 30 years from GreenMoney and Calvert!

We also believe that there will be a wave of new, independent, innovative investment firms and financial technology firms focused on ESG investing and positive change that will compete successfully with the mainstream investment industry. The changes we discuss above regarding transparency, information flow and government action and significant forces will signal innovators to start companies to solve climate and social challenges in the “real’’ world, and also spur new company formation in our own industry.

We are already seeing this happen, and many new entrants are doing excellent work and pushing the mainstream in the process. Institutional investors and retail investors indicate that they plan to invest more heavily into responsible and ESG strategies. There are new firms being created today that are doing what GreenMoney and Calvert set about to do 30 or 40 years ago. As this market expands, we are seeing waves of product innovation in our industry already, and we are really just getting started.

Along with new firms, new products, much greater transparency and positive government initiative will come increasing competition and professionalization of the responsible investing approach. One area we are confident will become central to the approach is the identification, quantification, analysis and, ultimately, market pricing of externalities. Expertise in this specific area is likely to be a critical differentiator between the firms that come to be the leaders of the next 30 years and the pack.

We have a very positive view of the future because the groundwork and infrastructure built will cause existing positive trends to accelerate. Yes, this is an uncertain time due to war, inflation, and a pandemic on top of climate change and inequality. However, for long-term, multi-decade players, the trends emerging today in responsible investing and better real-world outcomes are impossible to ignore. It seems like it took far too long to get to this point. But we are there, and the next 30 years will be very different.

 

Article by John Streur, president and chief executive officer for Calvert Research and Management. John is also president and a trustee of the Calvert Funds as well as a board director of Calvert Impact Capital and chair of its Audit and Finance Committee. He guided the creation of the Calvert Principles for Responsible Investment, the Calvert Research System and the Calvert Indices, and has placed focus on investment research and emphasis on environmental, social and governance (ESG) factors integrated with investment decisions. He joined Calvert Research and Management in 2016.

John began his career in the investment management industry in 1987. Before joining Calvert Research and Management, he was president and chief executive officer with Calvert Investments. He has managed socially responsible investments at the request of institutional clients, including public funds, religious institutions, and college and university endowments since 1991. Previously, he was president, director and principal of Portfolio 21, a boutique firm specializing in global environmental investing, and spent 20 years at AMG Funds (and its predecessors), a firm he co-founded and where he served as president, CEO and chair of the Investment Committee.

John is a founding member of the Investor Advisory Group for the Sustainable Accounting Standards Board (SASB), a group of leading asset owners and asset managers committed to improving the quality and comparability of sustainability-related disclosure by corporations for use by investors.

Disclosures

Risk Considerations Investing involves risk including the risk of loss. There is no guarantee that any investment strategy, including those with an ESG focus, will work under all market conditions. Investors should evaluate their ability to invest for the long-term, especially during periods of downturn in the market.

The views and opinions are those of the author as of the date of publication and are subject to change at any time due to market or economic conditions and may not necessarily come to pass. The views expressed do not reflect the opinions of all investment personnel at Morgan Stanley Investment Management (MSIM) and its subsidiaries and affiliates (collectively the Firm”), and may not be reflected in all the strategies and products that the Firm offers.

This material is a general communication, which is not impartial, is for informational and educational purposes only, not a recommendation to purchase or sell specific securities, or to adopt any particular investment strategy. Information does not address financial objectives, situation or specific needs of individual investors.

Calvert Research and Management is part of Morgan Stanley Investment Management, the asset management division of Morgan Stanley.