By Bruce W. Fraser

Environmental, social and governance (ESG) investing has become more mainstream during the past five years, fueled by rising investor interest and recognition that social and environmental impacts are creating material financial risks for companies and investors, according to executives at MSCI ESG Research & Indices.

One indication of this growing interest is that hundreds of investment firms worldwide have signed pledges to support the United Nations-backed Principles for Responsible Investment (PRI). The PRI, inaugurated in 2005, is a voluntary framework of rules by which investors can incorporate ESG principles into their decision-making and ownership practice.

Roughly 915 investment institutions with assets under management totaling approximately $30 trillion have become signatories, according to the U.N.

At a press briefing in New York last week hosted by MSCI ESG Research and Indices, company officials discussed key challenges and drivers in the ESG market, and outlined the scope of their expanding global activities.  

MSCI ESG Research and Indices, a research unit of MSCI Inc. in New York, consists of three main product lines: MSCI ESG Business Involvement Screening, which enables institutional investors to manage ESG standards and restrictions; MSCI ESG Impact Monitor, which lets institutional investors assess company involvement in major ESG controversies; and MSCI ESG IVA, which provides research, ratings and analysis of corporate management of environmental and social risk factors.

MSCI ESG Research and Indices' products are widely used in the investment industry by pension funds, sovereign wealth funds, banks and other financial intermediaries, as well as financial advisors and high-net-worth individuals. Hedge funds and wealth managers also are showing increasing interest in ESG investments, the company noted.  

"We look at ESG risk exposure, risk management and unmanaged risk on the one hand, and trends and opportunities on the other," said Martina Macpherson, head of MSCI ESG Research and Indices' marketing and commercial relationships.  
She added that asset managers use the company's research insights for analysis and ratings at both the company and sector level. "We help investors align their values-based mandates with in-depth ESG investment analysis, and uncover risks and opportunities not always captured by traditional investment portfolio practices," Macpherson said.

Noel Friedman, head of business development at MSCI ESG Research, said the key challenges that ESG investors face include identifying links between sustainability and profitability, identifying ESG risks and opportunities, and benchmarking key ESG performance metrics. Other challenges include communicating ESG exposures and complying with mandate requirements.

"They [investors] are looking at both the values side as well as the financial dimensions of ESG investments," Friedman said, "so they can gain a competitive edge and find better ways to integrate ESG factors into their investment decisions in order to identify new opportunities for alpha performance."  

According to the conference panelists, investors are demanding more precise ways to screen potential ESG investments over and beyond traditional means. In response, MSCI ESG Research and Indices is broadening the scope of their activities worldwide.

The firm's MSCI ESG Research team currently has 130 specialists--including 85 dedicated ESG research analysts--located in 13 offices worldwide. MSCI ESG IVA,  which effectively supports ESG integration into portfolio analysis, currently covers more than 2,000 companies, and MSCI ESG plans to increase that to 6,000 companies next year. Eventually, it wants to add a fixed-income component.  

Hewson Baltzell, who heads the company's product development team, said MSCI ESG Research and Indices' model derived from the legacy of sustainable investing research firms KLD Research & Analytics, Innovest Strategic Value Advisors, and RiskMetrics (formerly the Investor Responsibility Research Center). Through various acquisitions, all of these are now under the MSCI umbrella. As a result, the company says, it's the only major index provider with a global, dedicated in-house ESG research business unit.

MSCI ESG Indices comprise five main categories:
* Best-in-class companies with high ESG ratings relative to sector peers.

* Values-based indices including socially-responsible companies with ESG ratings that exclude companies involved in particular industries such as tobacco, nuclear power or genetically modified organisms. These indices also include companies compatible with particular religious values, for example, Catholic or Islamic beliefs.

* The universal owner category includes companies that comply with global norms of corporate behavior. Apt to be excluded are producers of controversial weapons or companies engaging in serious human rights violations.

* Environmental indices reflecting big themes including renewable energy, clean technology, and green building.

* Custom indices based on particular ESG requirements specified by clients.

Linda-Eling Lee, global head of MSCI ESG IVA research, said the firm's ratings aim to uncover medium- and long-term risks in order to identify winners and losers in the ESG sphere. The BP oil spill in the Gulf of Mexico is a prime example.

"BP was rated highly by many index providers, but its health and safety record was actually low," Lee noted. "So we removed the company from our then-legacy KLD index back in 2007."

But many companies hide or don't fully disclose information, she said. "There's not going to be full transparency necessarily all the time. You can't be right on every single company."