For asset managers, ESG is front, centre and here to stay
The landmark 2016 Paris Agreement paved the way for global corporations to take formal cognisance of the recently adopted UN sustainable development goals (SDGs). Rather than treating the SDGs as aspirational, government leaders began to work more closely with their private-sector counterparts across all big economic sectors to implement practical environmental, social and governance (ESG) initiatives.
These would contribute to the long-term sustainability of not only the economies within which corporations operate but the sustainability of the corporations themselves.
The earliest adopters to answer this clarion call were, unsurprisingly, asset managers, particularly in developed markets. Whether facing regulatory pressures themselves in terms of the moral or physical cleanliness of the assets they were investing in, the resultant trend intensified to the point where, according to global research and investment management firm Morningstar, in the first half of 2020 net inflows into ESG funds in the US reached $21bn.
European legislators took an even more aggressive approach, the European Commission issuing an array of regulations aimed at incorporating ESG elements into investment criteria, including a reframing of the ESG conversation in an effort for asset managers to change the way they approach product development, investing and reporting.
The European Commission’s action plan for financing sustainable growth announced in March 2020 included a guideline of an asset manager’s duties, noting the incorporation of sustainability considerations into the suitability assessment of financial instruments, as well as the inclusion of sustainability benchmarks.
In effect, fund managers have had to review their perception of sustainability urgently, as activist retail and institutional investors with shareholders and other stakeholder groups took a more demanding view of their managers’ investment processes as well as the composition of the underlying investments themselves. Consequently, as sustainability credentials influence consumer and investor decisions, ESG is now seen as a base for asset managers’ growth and opportunity.
According to KPMG’s Tomas Otterström, given that asset managers are both issuers and users of financial and nonfinancial ESG information, ESG-directed regulations also carry risk to managers of assets and allocators of capital — the sooner these practices and ESG considerations become entrenched in the organisational psyche or find a home as a standing item on the agendas of investment committees, the easier it will be to train teams on the ground. The hope, presumably, is that this will fast-track the inflow of assets.
In a recent interview with Nedgroup Investments the legendary US investor Mark Mobius declared the “G” in ESG (governance) to be the most important ESG factor informing his investment decision making. Mobius says when he invests in a company he undertakes to receive direct commitments from management to engage on issues to enhance governance.
Whether relating to board independence or the nature and frequency of communication with shareholders, Mobius has seen direct benefits through these management engagements, both in terms of share-price appreciation and through more transparent reporting and disclosure. Sustainable investments, he argues, “are those that benefit society and shareholders, so it’s a win-win situation”.
For local asset managers, ESG considerations remain at the forefront of assessing prospective investments and are material in terms of how underlying value and risk are considered. For example, Ninety One reports in line with the recommendations of the Task Force on Climate-related Financial Disclosures — established by the Swiss-based Financial Stability Board — to its investors and shareholders.
The asset manager also implemented certain advocacy initiatives to deepen the understanding and quality of ESG integration across its investment teams. Other initiatives included regular training and workshops with relevant subject matter experts to improve understanding in areas such as climate risk. Over time, management endeavours to formally embed ESG into the investment risk function.
As asset managers formulate responses to the growing calls of retail and institutional investors alike to place ESG considerations at the forefront of their investment processes, management teams must decide whether this is a legitimate process or simply a compliance exercise driven by a changing regulatory landscape. Asset managers could view this shift as an opportunity to align the purpose and ambitions of their businesses with those of their key stakeholders, and in so doing establish ESG as part of their value proposition.
Some investors are taking an active stance in advocating how companies can and should manage threats to the environment and society through their investment choices. They want asset managers to become more accountable in addressing these threats. In response, some fund managers have developed institutional and retail ESG funds, responding to growing investor demand.
PwC suggests a pragmatic approach for clients who want to implement a basic ESG practice (in the instance of it not existing) or undertake material enhancements to an existing ESG framework. Centred on three pillars; strategy, product offering and risk mitigation, a company can, with limited resources, make strides in this critical area of development.
Ultimately, ESG is a strategy that should be driven from the top down — adopted as a key agenda item by boards. From an organisational perspective, it is a function that must be embedded in the fibre of the organisation’s culture, purpose, and values.
As a business imperative, implementing a cohesive ESG framework and strategy should be viewed as an investment, not as a burdensome cost. ESG ratings show that funds rated higher on ESG indices consistently outperform those with weaker ratings.
Future-proofing businesses requires a longer-term approach to sustainability if companies intend to remain competitive. Achieving progress in this area will undoubtedly be value-accretive to the entire stakeholder base.
A version of this article was originally published here in South Africa’s BusinessLive.