ESG investing – a necessity or simply just good business practice?

An insight into environmental, social and governance (ESG) strategies within the investment management industry

W
ith the global COVID-19 crisis unfolding on a day-by-day basis, bringing restricted travel and country lockdowns, there has been an increase in both public and political awareness around environmental, social and governance (ESG) related issues.

In the long-term savings space, the increase in ESG awareness has been reflected in a quiet but substantial manner over the last few years, with trillions of dollars of assets under management (AUM) now invested in various flavours of ESG investment strategies. The growth in AUM has almost been matched by the increase in regulations focused on climate change, sustainable finance, stewardship and ESG investing.

With these observations in mind, EY undertook a survey involving some of the world’s largest asset managers, some of whom have embraced ESG for many years, to take the temperature of an industry undergoing massive change.

For this ESG survey, we interviewed those responsible for implementing ESG strategies across whole businesses to gain an understanding of where they think the most progress is being made. We also asked them about where more progress is needed both within their own firms and investors’ acceptance of this approach. There were 17 participants, with a collective AUM of more than £9.5tn.

We looked to understand:

1. Strategy and product offerings: What is their strategy on ESG and how are they developing their offerings to support this?
2. Market drivers — investment beliefs and client perspectives: What is driving the market in terms of investment beliefs and client demand?
3. Operations and product management: How are firms integrating ESG into operations and product management?
4. ESG reporting: How is the industry addressing reporting?
5. Future perspectives: What are industry viewpoints for the future? 

4. All the firms we spoke to have a very clear conviction and belief in the direction of travel of the market. Many see ESG as a key growth area and have been investing significant (£50mn +) sums to seed ESG strategies with an expectation of inflows in billions. This belief justifies the significant investments in data, systems and specialists that are helping firms to drive up standards around the industry. Despite the competitive challenges faced by the industry, investing in ESG capability is considered as simply good business sense. However, we found little evidence that asset managers were taking ESG factors into account beyond the investing process. Firms must also consider their own corporate activity, reporting, governance, and risk frameworks, and how these will all need re-orientating into client engagement, education and experience.

5. Demonstrable evidence of ESG capability will be critical to retaining and acquiring new mandates. Aspects including transparency on stewardship and engagement activities are considered key in demonstrating a strong ESG capability. Customers, both institutional and retail, must be able to understand what ESG means in investment strategies, and differentiate between different firms and strategies. This is an important reporting and product governance issue, and the industry must stay on top of it to avoid any potential issues in the future.

6. There is a proliferation of climate themed funds and strategies. Driven by TCFD1 and the recognition of potentially systemic risk posed by climate change investment portfolios have adopted a range of approaches to align climate exposure and global climate goals. With UK regulators, led by the Bank of England, working with Banks, Insurance companies and Pension schemes to move the dial on stress testing and scenario modelling, wealth and asset managers need to ensure they aren’t left behind and should think about how they leverage these initiatives in other sectors of financial services.

7. Impact investing is another area where several firms have developed strategies and are involved in global initiatives to develop standards around impact reporting. While this is an emerging area, a number of funds have been launched which are scaling rapidly. While private equity funds have led the way in launching multi-billion dollar funds, there are a growing number of listed equity impact funds on the market.

But in the minds of those we spoke with, financial returns are still king and will remain so, until we have a system of measuring returns that recognises and incentivises long term value delivery in its fullest sense, including positive environmental and social impacts.

However, ESG and impact themes are, in our view, moving from a customer choice to a survival imperative for asset managers. Winners will be those who are able to combine the digital, cost, distribution and reporting themes with a genuinely authentic ESG capability. They will have the potential to fundamentally redefine the customer engagement paradigm and change the narrative around the social purpose of investment management.