Global investors demand for ESG products continues to provide opportunity for organic AUM growth. Recent surveys indicate that client demand continues to be a catalyst for investment managers’ consideration of sustainability investment metrics in their decision-making processes.
At their current growth rate, ESG-mandated assets (defined as professionally managed assets in which ESG issues are considered in selecting investments) are on track to represent half of all professionally managed assets globally by 2024.
According to the Global Sustainability Investment Alliance (GSIA), in 2020 approximately $35 trillion in assets were being managed in line with ESG principles across major markets, about a third (36%) of all professionally managed assets. According to Refinitiv Lipper, 2021 was a bumper year for ESG-focused funds, with the sector attracting an inflow of $649 billion over the year.
Much of this growth in global ESG-mandated assets will likely be driven due to the adoption of the new disclosure regulations in EU. The implementation of the Sustainable Finance Disclosure Regulation (SFDR) in March 2021 effectively created three fund designations (Article 6, Article 8, and Article 9) based on the level of the investment manager’s incorporation of ESG characteristics in the investment decision-making process.
Together with this, the European taxonomy on sustainable assets is playing a pivotal role in providing standardised and unequivocal parameters to market participants, laying down the foundation of a general accepted framework for ESG screening.
As expressed by numerous institutional investors, although ESG regulations could be controversial, these funds sustain as a regulatory framework is paramount for the integration of ESG criteria in the investment strategies and wealth management, representing a reliable base for due diligence procedures and to reduce the risk of greenwashing and erratic ESG labelling.
ESG-mandated assets are on track to represent half of all professionally managed assets globally by 2024. ($T) Source: GSIA
So ESG investing has moved centre-stage within the global investment arena in recent years.
It is one of several approaches to investing which is as concerned with its impact on people and the environment as it is with potential financial returns.
As ESG practice sounds noble, the proper application can be challenging: for example, the metrics used to work out whether a business can be described as ESG-worthy can often be subjective. There are different frameworks used to assess the credentials of a business, with ESG factors being calculated using varying methodologies, ranging from regulatory issued framework, authority guidelines and best practices.
Additionally, there are data providers which help inform fund managers with their decisions by issuing ESG scores and ratings based on several metrics and factors being impounded in the ESG assessment.
However, aside from the issue of whether a particular company or fund passes the ESG test, there are other considerations for investors to bear in mind.
Screening out individual companies and entire industrial sectors can increase the risk that the investment will miss out on growth opportunities, reducing diversification and eliminating potentially profitable investments.
On the flip side, the extra analysis associated with ESG measures means investors may end up with exposure to better-managed companies.
Nonetheless, in recent times the debate is shifting from how investment managers should respond to ESG to whether executives are backing away from ESG as recession risks mount.
The instability brought around by the Russia-Ukraine war, the inflation soaring, the energy conundrum, the geopolitical instabilities in key countries and the tightening of the monetary policies are factors that are already generating margin contraction in businesses, and executives are putting several ESG goals on hold as they try to prepare their business for the fallout from a possible recession.
This is what emerges from a recent KPMG survey, where most of the executive surveyed said they generally consider environmental, social and governance issues to be an integral part of their success. Because of the challenges posed by a shrinking economy, businesses are now struggling to balance “mid-term environmental issues while hunkering down to protect short-term economic and social stability”.
Uncertainty defines as spending resources on ESG goals that aren’t fully define within regulatory frameworks is slipping down the list of priorities, together with some first sign of scepticism toward ESG from investors.
Indeed, ESG equity funds faced headwinds in their portfolio on two fronts this year. Technology stocks, which ESG funds tend to be overweight on because they are perceived as more environmentally friendly, underperformed the boarder market. And oil and gas stock, which many ESG funds are underweight because of concerns about climate change, outperformed thanks to a rally in energy prices.
With challenging times and unprecedent events, some financial advisors are planning to decrease the use or recommendation of ESG funds over the next year, even if positions are differentiated.
There are some investors that clearly state as financial performances and returns are higher priority than ESG impact right now, but fortunately, a huge portion of portfolio managers are sticking to these asset classes given the greater investment horizon and the long run expected results, both on financial and ESG aspects, as they tend to be less performance-focused than traditional investor, with a willingness to commit and stay with companies through periods of volatility.
Some commentators believe incorporating an ESG strategy involves accepting a trade-off, in other words, accepting lower returns as a trade-off for doing good. Others believe the opposite and there could be a mismatch between financial interests and value creation relatively to the achievement of ESG results and greater return for the society at large. A mismatch that potentially could slow down the implementation of promising sustainable projects due to short sighted investors and slower financial performances.
It should be noted as ESG investing remains susceptible to human factors and values, namely fear and greed. Individual companies and industrial sectors popular with ESG investors will end up overvalued if they are hyped up too much.
In this scenario, mispriced assets could pave the way for a period of underperformance, but this should not be an invalidation of the practise, rather evidence of human nature bias.
Source: KPMG, Bloomberg, ESG News, Forbes, IlSole24Ore
These materials are provided for general information and educational purposes based upon publicly available information from sources believed to be reliable — we cannot assure the accuracy or completeness of these materials. The information presented is not intended to constitute an investment recommendation for, or advice to, any specific person. The information presented here is not specific to any individual’s personal circumstances. To the extent that this material concerns tax matters, it is not intended or written to be used, and cannot be used, by a taxpayer for the purpose of avoiding penalties that may be imposed by law. Each taxpayer should seek independent advice from a tax professional based on his or her individual circumstances. The information in these materials may change at any time and without notice.
