Main Content

Environmental, Social & Governance Investing - "ESG" Standards

Updated: February 1, 2020

Issue: The drive for public pension systems and other institutional investors to use environmental, social and governance standards when making investment decisions has grown tremendously in the last few years.

There are two general theories behind ESG investing. One is that “the economic power of the portfolio” can lead people, companies – and even governments – to change policies or laws to fit the demands of people who want change in specific areas.

The other suggests that companies which use ESG principles as part of their decision-making process may be better positioned for success in the future global economy and could potentially outperform companies that have not embraced these issues.

The range of standards that can be used is wide. The actions that can result from the use of these standards also is varied. Most so-called “ESG investments” are measured by the affect they have on three basic areas of concern:

  • Environmental – Actions and practices that mitigate detrimental changes in the climate.
  • Social – Actions and practices that improve living conditions on several fronts, including health care, equality, safety and quality of life.
  • Governance – Actions and practices that affect how private businesses operate their firms and treat their employees and customers.

According to the latest biennial report from the United States SIF Foundation, the allocation of assets by investors to ESG investments was $12 trillion in 2018. ESG investments have increased 13.6 percent per year since the Foundation began measuring ESG commitments in 1995. The largest portion of the $12 trillion allocation – $8.6 trillion – were investments made by institutional investors like government pension systems. (1)

Another study, conducted in 2019 by RBC Global Asset Management, indicated that 70 percent of institutional investors in the United States, Canada and the United Kingdom, “apply ESG principles to investment decisions.” (2)

However, despite growth in the use of “ESG” standards, the concept remains controversial. With regard to the assets held by government retirement systems like TRS:

  • Supporters of the use of ESG standards say the assets “are public money and should serve some public purpose beyond providing retirement income security” for plan members. (3)
  • Opponents of the use of ESG standards say retirement system assets “are held in trust… for the exclusive financial benefit of plan participants, without exception.” (3)

State of Illinois Action: In 2019, TRS enacted a new investment policy regarding sustainability issues that cover a number of the areas of concern. The State of Illinois requires all public pension systems to adopt an investment policy to oversee sustainability standards. Here is the TRS policy:

Sustainability Policy Statement

Pursuant to 40 ILCS 5/1-113, TRS shall include material, relevant, and decision-useful sustainability factors that will be considered by the Board, within the bounds of financial and fiduciary prudence in evaluating investment decisions. These factors consist of, but are not limited to:

  • Corporate governance and leadership factors
  • Environmental factors
  • Social Capital factors
  • Human capital factors
  • Business model and innovation factors

In addition, TRS’ efforts will include prudently integrating the following:

  • Periodic evaluation of sustainability factors to ensure the factors are relevant to the TRS investment portfolio and the evolving marketplace; and
  • Periodic monitoring of investment managers to encourage implementation of the aforementioned factors.

As a long-term investor, TRS is focused on the performance of its investments now and in the future. Material criteria that integrates this policy into investment decision making will be included in due diligence, investment analysis, and asset and portfolio management.

TRS also is subject to state laws that for many years have restricted System investments under certain circumstances. Specifically, two separate laws prevent TRS from investing money with companies that are connected with Sudan or Iran. Also, state law prohibits TRS from investing money with any entity that “boycotts” the State of Israel. These investment restrictions and others are overseen and administered by the Illinois Investment Policy Board.

Background: So-called “socially responsible investing” began in the 1960s with investors excluding companies from investment because of the investors’ opposition to business activities or the companies’ location in a country with laws and policies that were deemed harmful to society. This social responsibility was based on individual, corporate or government ethics and values. For many years these divestment policies focused almost exclusively on two areas – the tobacco industry and apartheid in South Africa. (4)

In the last 50 years, social responsibility standards and the use of these principles has evolved. In some instances, the use of these standards is based on actively choosing companies “because of their positive ESG attributes, as opposed to excluding certain industries or companies because of their ESG liabilities.” (5) In other cases, following ESG principles has led institutional investors to commit funds and then actively engage companies through communication and shareholder votes to change policies and practice so they better adhere to socially responsible standards.

Others, however, say that the “power of the portfolio” is over-rated. “Corporate management does not care who owns their stock,” said Gary Findlay, former executive director of the Missouri State Employees’ Retirement System. “In any case, isolated sales will not materially affect the stock price.” (3)

Another part of the ESG evolution is the expansion of issues and concerns that ESG activists monitor and want investors to use to generate change. As it has for decades, the tobacco industry continues to be an ESG concern. Other general areas include:

  • Slowing or stopping the use of fossil fuels to prevent the effects of man-made climate change
  • Improving humankind’s stewardship of natural resources, manufactured products and waste
  • Preventing gun violence
  • Stopping international terrorism
  • Advancing human rights and equality in society and the workplace
  • Controlling advances in technology and communications, such as social media

The increased popularity of ESG investing by corporate and institutional investors can be linked directly to a growing interest in the concept by the general public and individual investors. A 2019 report by Allianz Life, a financial services company, indicated that more than half of “millennials” working with a financial advisor have discussed ESG strategies. “Social issues are becoming larger driving factors for many investors…” including older age groups. (6)

There is an ongoing debate on where ESG standards stand with regard to a retirement system’s fiduciary duty to its members. That duty is traditionally understood to mean prudently investing the members’ assets and enhancing earnings as much as possible for the members’ retirements.

Some argue that ESG principles are a required part of a retirement system’s fiduciary duty; others argue that ESG violates a system’s fiduciary duty.

“ESG factors are related to a firm’s long-term financial performance; the duty of prudence requires a trustee to consider material information; and therefore, trustees have an obligation to integrate ESG factors in their decision-making if they are to fulfill their fiduciary duties.” (5)

“…delivering shareholder value and furthering social progress are not mutually exclusive,” said Nigel Wilson, CEO of Legal & General, to the trade publication Pensions & Investments. “It is the opposite – for companies to prosper in the long run, it is imperative that they be socially as well as economically useful.” (7)

Those who say ESG standards violate a system’s fiduciary duty point to research that says ESG-driven decisions lower returns. According to the Wall Street Journal, “There is some evidence that divesting from certain holdings can be costly for systems that oversee retirement savings for millions of public workers. A November 2016 study by the Boston College Center for Retirement Research found average annual returns in states with divestment requirements were 0.40 percentage points lower than plans in states without such requirements.

“Divestment mandates ‘detract from what a retirement fund is for, which is to provide retirement income for public-sector workers,’ said Anqi Chen, one of the study’s authors.” (8)

“…ESG investing is seen as violating the fiduciary duty of loyalty, which requires a trustee consider only the interests of the beneficiary…a trustee’s use of ESG factors, if motivated by the trustee’s own sense of ethics or to obtain collateral benefits for third parties, violates this duty of loyalty.” (5)

In addition, those who oppose the use of ESG standards point out that as interest among individual and institutional investors has grown, so has the number of causes and issues that want to fall under the ESG umbrella, even if they lack sufficient academic proof that they support or result in a desirable ESG outcome.

Securities and Exchange Commissioner Hester Peirce was quoted in the Wall Street Journal in 2019 that she is critical of ESG standards, “for having no enforceable or common meaning…ESG factors rely on research that is far from settled…I think that should be part of the discussion, trying to figure out to what extent ESG might stand for ‘enabling stakeholder graft.’” (9)


(1) Pensions & Investments – August 19, 2019 “Public funds taking the lead in spectacular boom of ESG”

(2) Pensions & Investments – October 16, 2019 “70% of institutional investors apply ESG to investment decisions – survey”

(3) Pensions & Investments – June 15, 2015 “The divesting puzzle: perception and reality”

(4) RVK, Inc. Presentation to the TRS Board of Trustees – April 27, 2018 “ESG Discussion”

(5) National Council on Teacher Retirement – This Week’s FYI – September 9, 2019 “ESG Investing and Fiduciary Duty”

(6) USA Today – August 28, 2019 “Socially conscious investing can be tricky.”

(7) Pensions & Investments – August 22, 2019 “New coalition looks to align business goals with impact investing”

(8) The Wall Street Journal – June 17, 2019 “Pensions Reconsider Linking Investing to Social Concerns”

(9) The Wall Street Journal – December 17, 2019 “SEC Questions Do-Good Funds”