Neuroscience teaches us that branding matters because our brains remember things by categorizing them. If we feel an affinity for a particular category of product, whether real or imagined, we are more drawn to that product than similar products that our brains place in different categories.
As automotive brands go, Subaru has had more success than most into developing niche products that have a loyal following among specific demographic populations. Even though the automaker is part of the huge Japanese conglomerate Fuji (the six stars in Subaru’s badge represent the six companies that merged to create Fuji), Subaru is not an all-things-for-all-people automaker. As automotive products became more homogenized, Subaru used horizontally-opposed cylinder boxer-configuration motors (improves ground clearance while lowering the center of gravity) and all-wheel drive powertrains to make functional cars that serve the needs of the daily commute and the weekend adventure (even if that adventure is just to Costco).
Many of my blogposts include stories about automobiles because investment management firms, like automakers, make their way by developing unique products that serve particular customers and particular needs. All cars are transportation and are ultimately designed to get you from point A to point B. All investment products are ultimately designed to make as much money while taking as little risk as possible. But commodification is bad for MSRPs and fee schedules, and ultimately bad for margins and company sustainability. Product development has been an antidote for commodification since the development of growth versus income strategies 40 years ago, and remains so today.
Investment strategies that screen for environmental, social, and governance criteria (ESG) is a still developing product niche that has, until recently, been more about talk than action. The pitch is that investing in businesses that demonstrate broad-based corporate responsibility provides a pathway to management teams who think long term, mitigate risk, and lead their industries. Demographic studies have shown that ESG strategy is particularly appealing to millennial investors and women. Millennial investors will, of course, eventually control the majority of investible assets. Women already do.
The beauty of an investment product like ESG is client stickiness. Subaru has a remarkable level of customer loyalty (with a 68% repurchase rate), and RIA’s providing competitive ESG products get some escape from the quarterly (or monthly or daily) comparison with the indexes. Client stickiness adds value to an investment manager in many ways, and ESG holds the promise – at least in the near term – of AUM retention in a way that other investment strategies do not.
Nevertheless, in the RIA world, the rubber meets the road at performance, and many investment managers still shy away from ESG screens because they want the alpha that’s often inherent in “sin” stocks, or because their investment criteria just don’t overlay with ESG very well. For these reasons, the scale of ESG has, until recently, remained modest. The product category got a big boost a few years ago when Deutsche Bank published a research paper heralding the success of ESG in identifying companies with a lower cost of capital and outperforming business models. Since then, other studies have generally confirmed the result.
As a consequence, the investment strategy is growing in an era when active management is otherwise losing ground. The question many are asking today is whether or not the election of Donald Trump will cause the trend line to roll over, marginalizing ESG as an idea out of sync with the markets.
We think not. ESG is more common sense than high-minded idealism. Since the structural framework of ESG is not based in altruism, but in sustainable investing and risk mitigation, there is still ample reason to pursue it. Studies of investment returns show not only correlation but causation for the value of screening for environmental, social, and corporate governance issues. Thus, from a fiduciary’s perspective, ESG is prudent. And regardless of the political climate in the U.S., the crowd sizes that formed across America the day after the inauguration suggest that the new administration is not necessarily going to be a cultural vanguard. Instead, some political activists may see ESG as a way to right certain issues in the global balance that can’t be accomplished at the ballot box.
This isn’t to say ESG will appeal to everyone. Not everyone wants to drive a Subaru; some prefer a Nissan. But for those who want it, ESG is a niche product that is still on the rise, and the current social environment in the developed world may provide a catalyst to that.