Wall Street's activist investors, once known for pushing for extreme cost-cutting or just about anything that would boost the bottom line, are starting to use their money to promote a different kind of corporate action: social and environmental change.
They are doing this, they say, not only as a matter of moral responsibility, but for their original mission of generating better returns for their clients.
Socially responsible investing, long the bastion of faith-based activists and civic do-gooders, can now count several high-profile activists — including Clifton Robbins of Blue Harbour Group and Barry Rosenstein of Jana Partners – among its acolytes. This kind of investing is known as "ESG" for environmental, social and governance factors.
Assets under management in U.S.-based socially responsible investing strategies climbed to $8.72 trillion at the start of 2016, roughly 20 percent of all investment under professional management and an increase of 33 percent from the start of 2014. Those numbers — published every two years by US SIF: the Forum for Sustainable and Responsible Investment, a Washington, D.C., trade group whose members include numerous mutual and pension funds — are likely higher given the growing interest in the space.
While research remains limited, early academic analysis from Harvard Business School finds firms with an emphasis on environmental and social issues have a significantly higher annualized return.
In an annual speech to hedge fund leaders last Tuesday, Robbins, Blue Harbour's chief executive, said that social and environmental considerations have become integral to how the fund's partners decide where to invest its $3 billion in assets.
"This is hugely important – I think this is a new paradigm for smart investing," he told the crowd at the 13D Monitor Active-Passive Summit last week. "Now when I'm calling up a CEO three months after we make an investment, in addition to saying: 'Where are we on the spin-out? Where are we on the balance sheet? Where are we on the margins?' I'm saying, 'Where are we on that commitment you made to me to make the board more diverse?'"
Known as "the friendly activist," the Greenwich, Connecticut-based hedge fund prides itself on having never sued or run a proxy contest against a company since Robbins first founded the firm in 2004. Instead, Blue Harbour has made a name for itself through meticulous work with company management, a process Robbins considers "one of the most important" in determining whether to invest.
That simultaneous focus on both management and ESG was recently put to the test when the fund accrued a 4 percent stake in software company Open Text, according to David Silverman, managing director at Blue Harbour who quarterbacks the fund's ESG efforts.
For an industry infamous for its lack of gender diversity, Open Text's decision to appoint Madhu Ranganathan as chief financial officer this month came as welcome news to the Blue Harbour team.
"Open Text just added a new CFO who happens to be a woman of diverse background ... we think she's going to be a great CFO," Silverman told CNBC. "That's important at a tech company, as more broadly in the industry there have been issues of diversity and inclusion."
While taking steps to diversify a company's management or board may have its own ethical benefits, Silverman reiterated that Blue Harbour's focus on ESG stems from financial interest. It's those types of company-specific ESG concerns, he said, which can help concentrated activists unlock previously hidden value.
But Blue Harbour isn't the only activist fund integrating socially responsible investing into fund management.
Rosenstein's Jana Partners also has been exploring the space, most recently hiring former BlackRock fund manager Dan Hanson to oversee a new fund targeting companies on issues like climate change and wage inequality, according to a Reuters report.
Jana is recruiting several social activists (and rock star Sting) to pool cash for the fund – expected to be called Jana Impact Capital – in its effort to put pressure on companies they feel can be better corporate citizens.
In kicking off its latest push into socially responsible investing, the $5 billion hedge fund teamed up with the California State Teachers' Retirement System (or CalSTRS), which controls roughly $2 billion in Apple equity, to urge the iPhone maker to develop new settings to help parents control children's time on mobile devices. Jana believes could easily fix what the firm sees as a pernicious problem of young people getting addicted to the tech giant's phones.
"This should be an easy fix for Apple," Rosenstein told CNBC in January. "There's no question that it needs to be more responsive to children's needs and children's activities."
The fund manager added that he's received "hundreds and hundreds" of letters and emails from parents supporting his position, which reflects the need for a fix.
"There's overwhelming agreement in the general public about the need for this," he said.
A forthcoming paper from Harvard Business School has given investors early hope that these types of investments could lead to more than good public relations.
Part of the problem in determining whether firms with a focus on ESG outperform peers is parsing out which companies are "for real," according to Harvard Business School professor George Serafeim, who leads the school's research and curricula center on corporate sustainability. For those who can pull it off, the rewards appear to be starting to show.
Serafeim and his colleagues found that firms scoring in the top quintile of the total quintile of the total MSCI KLD index – a list of 400 U.S. securities with exposure to companies with ostensibly good ESG ratings – post significant, 2.16 percent higher annualized stock returns.
This outperformance, his research finds, is driven solely by firms at the top quintile of a custom-designed materiality index, with companies in the top quintile of the index outperforming the market by 6.47 percent annually.
"How can you say you've factored in ESG issues when you been invested in energy companies for years and yet have not had a single conversation about capital expenditure on emission?" Serafeim told CNBC. "What we have learned is that some of the ESG issues are actually financially material. ... Hedge funds are recognizing that, from the deep value perspective, this is a very useful lens."
Source: Hedge Fund Research, Inc.
So many companies now identify sustainability issues as strategically important that the "materiality" of the reported sustainability investments for firm value is harder to determine, Serafirm said.
For example, ESG issues for large internet and data companies like Facebook and Google – such as data privacy and employee diversity – are material issues. In contrast, for household and personal product companies like Procter & Gamble and Unilever, packaging life cycle management and supply chain impacts are more material.
However, Harvard's early research shows that of the more than 2,000 companies examined, those that drill down on firm- or industry-specific, "material" ESG issues significantly outperform.
Questions remain for the trend in the short term, however, as President Donald Trump's administration actively pursues topics considered antithetical to long-term environmental sustainability.
The president has resurrected the Keystone XL and Dakota Access pipelines, sought an end to "the war on beautiful, clean coal," called climate change a hoax, pulled the U.S. from the global climate agreement signed in Paris in 2015 and appointed Scott Pruitt -- who's promised to roll back emissions regulations – as head of the Environmental Protection Agency.
"This is a great benefit to the fossil fuel industry, to traditional investors in coal mines," said James Henry, former chief economist at McKinsey and senior fellow at the Columbia Center on Sustainable Investment. "The regulatory environment has also shifted against ESG investing. The EPA has essentially been strip mined."
"All of that doesn't augur well for U.S.-based ESG companies," he added. "It's hard to believe this will be helpful to companies like Tesla, which are struggling to finance themselves anyway."
Still, it's unlikely Trump's actions alone could stem the flow of cash into sustainable investments. A burgeoning body of literature has hinted that companies that prioritize firm-specific ESG issues also tend to outperform as long-term investments.
Analysts at advisory firm Institutional Shareholder Services have also been following the trend as more and more funds express interest in the area.
"It is helpful in particular to the hedge fund space, where we're only now getting information in recent years," said Marija Kramer, head of ISS' responsible investment business. "We definitely have clients that look at just straight gender balance and others that look at experience, what committee which board members are sitting on, and whether that's in line with the company's business practices."
Kramer told CNBC that funds have come to ISS for advice on a variety of topics, from staying ahead of reputational risks on hot button issues like sexual harassment to incorporating green energy into their portfolios. The growing interest in ESG has, in turn, been accompanied by new ways of measuring sustainability, she added.
"It's more quantifiable now," Kramer said. "In addition to having the historical content, there's more research into the impact of ESG investment. ... It could even help performance."
Despite the early optimism behind the shift to ESG investing, it's clear to Pershing Square's Bill Ackman that Wall Street still has a lot of work to do when it comes to gender balance in activist investing and corporate board representation.
"I actually have wanted to run a proxy contest with an all-female, diverse, ethnic slate. I think, first of all, that it would send an incredible message. And I think we'd win, hands down," Ackman said at the 13D Monitor summit. "The difficulty for us has been recruiting directors, and in particular women in an activist context."
Ackman said he had initially considered two female directors for his Automatic Data Processing slate last year, but that one of the women dropped out as the bid became hostile. Pershing Square, which raised $500 million from investors to take a stake in ADP, eventually lost its proxy fight with fewer than 25 percent of the vote.
"We had a phenomenal female director for our ADP slate, we had one on our slate," Ackman said. "But we had another phenomenal director and she had been on the board of very important, interesting companies. She completely understood all the issues, she had a superb, relevant resume, but once it was a proxy contest she wasn't going to participate."
"I think what the shareholders can do is, the big institutions can make clear that the fact that someone hasn't served on a board before shouldn't disqualify them from being a credible candidate for the board," Ackman said.