How wealth and asset managers are mainstreaming ESG and long-term value strategy

ESG, with its core values around sustainability, resiliency and stakeholder value, is a cornerstone of long-term value creation, but the two strategies differ in a significant way. ESG is focused on enhancing the company’s relationship with the world around it, creating a purpose that goes beyond making money. Long-term value embraces ESG’s principles but also acknowledges the need to generate profits and higher valuations — a notion that resonates with most FI leaders.

What has changed is the growing recognition that ESG-related factors, such as a company’s carbon footprint, commitment to diversity, community engagement and governance practices, can influence financial performance. FI leaders and investors understand this intuitively but need guidance in a fast-changing environment to make decisions that create opportunities for wealth and asset managers.

Increasingly, investors are looking to ESG as a foundational part of their asset-allocation strategies, with 88% of asset owners in Cerulli Associates’ 2020 ESG Report[1] saying they place at least moderate importance on managers having ESG capabilities. The demand is highest among Gen Z and millennial clients.

Wealth and asset management firms are responding. In Europe, 94% of institutional investors reported adopting ESG practices, according to a 2020 survey[2] by RBC Global Asset Management. In the US, 65% of institutions said they had embraced ESG principles.

Many more are adding language about ESG priorities and criteria to their investment policy statements. At least 200 new funds with ESG investment mandates are expected to launch during the next three years. As one asset manager puts it, ESG used to be viewed as a cost center with intangible benefits; today, it is seen as an engine for driving profits and market value.[3] For FIs, ESG is no longer a niche; it’s becoming a strategic imperative.

Effective ESG relies on solid analytics, but the quality and consistency of issuer disclosures varies — the lack of a uniform framework can make corporate comparisons difficult.

The scorecards of ESG rating firms are not aligned, either. Nearly a dozen different agencies each employ their own criteria to those uneven corporate reports, leading to different interpretations and guidance. For example, an oil company might rate highly on one scorecard due to its disclosures and internal procedures but poorly on one that weighs industry emissions more heavily.

The regulatory landscape around ESG is subject to the whims of an ever-changing political environment, making standards and related reporting complex to navigate and difficult to predict. Requirements already vary widely by region and jurisdiction.

Perhaps the most significant roadblocks are cultural. Firms that embrace true ESG or long-term value strategies often make their organizational structures less siloed and create new performance metrics around diversity, emissions-reduction and other long-term goals that might not provide immediate payoffs. In contrast, many FIs continue to focus on short-term shareholder returns.

For FIs, having the products, services, capabilities and cultures to serve consumer appetites for ESG investing is emerging as a pathway to growth, but adoption is uneven. While some have embraced innovation, others feel paralyzed by the idea of transforming or are cynical about ESG’s virtues.

In broad terms, most FIs fall into one of four archetypes:

• Leaders. Companies like Calvert and Walden Asset Management have branded themselves as ESG specialists and are constantly improving financial metrics around the long-term environmental and societal impact of their investments.
• Fast followers. The most common group, these companies understand the value of long-term value and ESG strategies but are not fully committed. They don’t want to be left behind but don’t want to invest (or overinvest) in the wrong approaches either.
• Check-the-boxers. These companies haven’t totally bought into the value of the long-term value/ESG strategies but want to make sure they look good and check the appropriate compliance boxes.
• Skeptics. These companies and their numbers are dwindling. They think the entire long-term value/ESG movement is a fad and shareholder returns remain the primary standard by which investments must be measured.

Fast followers who want to build reputations as ESG market players can reorient their thinking holistically around four distinct pillars of value:

• Financial value. How does the company’s competitive strategy align with financial priorities? For example, 92% of Vanguard’s stock funds outperformed their peers over a five-year period,[1] forming a foundation for long-term client returns and its own growth. The ability to deliver measurably beneficial value propositions is important to overall ESG success.
• Customer value. How do innovative product design, development and delivery help meet end-user needs? State Street established its global clients division in 2018 to deliver cross-enterprise solutions to its most sophisticated clients, leveraging a holistic, front-to-back platform to transform those relationships into strategic partnerships. Enabling seamless access to expertise, insights and solutions can make relationships more meaningful and “sticky,” leading to greater wallet share.
• People value. How can the company structure and enable its workforce to support ESG priorities? In 2020, Invesco launched Learning Hub, a user-experience platform that leverages artificial intelligence to aggregate and deliver customized courses, articles, podcasts, videos and other educational materials through its network. Helping employees achieve professional goals and improve personal well-being can inspire greater buy-in and loyalty.
• Societal value. How does the FI’s value proposition fit with broader societal goals? Brookfield has built a private-sector renewable energy business and made its facilities available for medical testing, blood drives and other philanthropic activities to strengthen local connections. Building strong relationships with external stakeholders lies at the heart of creating a purpose beyond making money.

The strategies that emerge will vary by institution, depending on target markets and existing capabilities. If executed well, the interactions among the four pillars can play out in a virtuous circle that enhances the FI’s value to all stakeholders.

Fast followers intent on taking the next steps can start by addressing the following considerations:

• Establish long-term value goals. Assessing stakeholder needs and the company’s competitive position can help define specific, tangible strategic growth objectives and understand what is needed to achieve them in terms of products, public commitments and culture.
• Identify needed capabilities. Reviewing ESG data and architecture requirements, including reporting solutions and personalization efforts, can inform strategic choices. Embedding a defined set of ESG products and data solutions — including artificial intelligence and big data — into front-office, marketing and risk-management systems is crucial to success.
• Determine how best to add those capabilities. Building a framework to assess build, buy or partner opportunities can inform decisions on the most effective ways to gain products and capabilities. While owning a product or capability is desirable when it is central to differentiation efforts, it is often faster and less costly to partner.
• Assess talent needs. Determining the expertise required to execute an ESG strategy is important. ESG requires specialized product, market and cultural expertise, which many FIs must find. People skills are often a primary motivator of M&A deals.
• Build regulatory understanding. Identifying short-term ESG risks and regulatory action points early can enable FIs to begin implementing climate- and social-related disclosures, stewardship and other reporting requirements. Regulatory definitions remain works in progress and can vary by region but have a greater impact on strategy.
• Develop a road map. Building a short-, medium- and long-term plan for integrating ESG objectives into the business can define priorities and create a vision for driving results across the full value chain. Executed well, ESG strategies can change how an FI interacts with stakeholders and makes money.