I don’t know about you, but the volume of environmental, social, and corporate governance (ESG) and responsible investing (RI) related articles appearing on my screen has been increasing exponentially this year. It doesn’t seem very long ago when progressive clients were those asking about how to automate “sin stock” restriction monitoring in their portfolios. How far we have come! ESG/RI has reached the big-time and investors are demanding better ways to measure the sustainability and societal impact of their investments as they continue to put an increasing portion of their money into these strategies.
ESG/RI assets are growing
Investors are pouring more money than ever into ESG/RI products. ESG Equity ETFs represent 0.8% of total equity ETF assets, yet they have accounted for over 30% of all equity ETF flows thus far in 2020. Banks are getting in on the action and issuing ESG bonds at a record clip with Moody’s reporting $55B of ESG bond issuance in 2019 and estimating that to rise to $150B in 2020. In Europe, pension fund managers are taking climate change risk into account when it comes to investment allocations as a recent survey from investment consultant Mercer showed: “89% of pension funds now consider wider environmental, social and governance risks as part of their investment decisions, up from 55% last year.”
This growth in assets is not just coming from the tree hugging do-gooder crowd. To the victor goes the spoils and ESG/RI strategies are winning. No longer does one have to trade off performance for making impact investments. As stated on the popular ETFtrend.com site, “Investors have been able to observe the performance of ESG ETFs through historic bear and bull markets in the last three years alone and the returns so far have been favorable to ESG strategies relative to conventional passive indexes and ETFs.”
Challenges lurk
As with any worthy act of progress, there are obstacles on the path ahead. The US Labor Department recently proposed new ERISA rule changes in order to limit ESG investment options in employee 401(k) plans. Segments of the energy sector are on the defensive as investment managers reduce positions in fossil fuel companies over concern about the climate crisis.
There are also threats from within the ESG community. A lack of standards measuring ESG/RI scores threatens the credibility of rankings that investors seek to make good decisions. Investors hate uncertainty. Without standards and rigor around ESG/RI data, we are left with subjective measures to verify that investment results are in line with the espoused principles of investors. As such, the CFA institute is getting involved and working with the investment community to establish standards for analyzing ESG products.
The long-term picture for ESG/RI looks bright
BlackRock CEO Larry Fink said climate change has become a “defining factor in companies’ long-term prospects” with a significant reallocation of capital on the horizon a lot sooner than expected. Brown Brothers Harriman global ETF survey results published earlier this year revealed ESG as the strategy investors most want to see more of with 30% of respondents expecting to have between 11% and 20% of their portfolio in ESG ETFs within the next 5 years.
Mega trends trackers take note. Momentum like this is going to play a part in shaping which companies generate the most value over time, in all is its various measures. ESG/RI strategies have a great deal of appeal for those who rigorously pursue every ounce of alpha as well as for those who measure success in broader ways. Brand identity is real to consumers and a similar ethos is increasingly in demand by investors. It is encouraging to see this growing investment class create opportunities for better short- and long-term societal outcomes while also generating positive financial returns. The momentum has reached a critical mass and its impacts will continue to influence decisions and outcomes for firms across the investment management spectrum.
We’d love to hear your perspectives on the opportunities and challenges you are thinking about as you contemplate ESG/RI strategy offerings. My colleague David Quirk wrote a great blog on what ESG means for technology and operations—if you’re looking for guidance on how this evolving landscape affects the operating model, I encourage you to start there. As always, feel free to share comments below and/or drop us a note to discuss further.
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