Leaders in the UK and US may have cooled on ESG but returns have been good and investor interest remains strong.
Investors’ enthusiasm for ESG (environment, social and governance) strategies has been lacking this year. Leaders in the UK and US have retrenched on good intentions and attention has been elsewhere investment-wise, despite the S&P 500 ESG index returning a positive 26.52 per cent year on year, slightly higher than the S&P 500 which has a return of 26.11 per cent over the same timeframe.
But a changing of the guard politics-wise in the UK, and a potential one in the US, could provide impetus for investors to sit up and take note. ESG is also widely expected to become a standard part of everyday asset allocation instead of a standalone investment strategy. Investors automatically invest taking ESG considerations into account.
Investors want more
“Essentially, we are now seeing a convergence of government, business, and the public wanting more. This will drive opportunities, investment, and prosperity,” says Rav Hayer, senior adviser at US global consulting firm Alvarez and Marsal.
A report by McKinsey confirms that the interest is there from investors, but a lack of transparency from companies, combined with a confusing array of metrics makes life harder than it should be.
While more than 95 per cent of S&P 500 companies issue a sustainability report, very few fully integrate ESG factors into their equity stories, according to the study. “The lack of a clear link between sustainability and strategy can make it difficult for investors to understand how a company’s efforts affect financial performance and, crucially, intrinsic value,” it says.
Transparency issues should be mitigated with the US regulator challenging greenwashing.
“Given the US regulator's direction of travel on ESG broadly, and its anti-greenwashing stance, I suspect investors will, going forward, feel they have the tools and reporting to feel more confident around ESG,” says Mr Hayer.
In the UK, the government’s commitment to becoming a green energy superpower will need to be mapped out in detail.
The commitment from the new Labour government in the UK towards clean energy “will attract investment and the need for people to deliver on those promises, such as energy independence from dictator countries, forcing water companies to clean up rivers, warmer homes to slash fuel poverty, and so on,” adds Mr Hayer.
So, will there be plentiful opportunities to invest, and will asset allocators be able to see clearly where the opportunities lie and whether companies are making good on their stated objectives?
“The broader purpose of creating a sustainable business has never been out of favour. This is an important distinction to make. It comes down to terminology versus purpose,” believes Davina Goodall-Smith, independent adviser at DGS Advisory, a UK-based independent consultancy.
One of the biggest hurdles will be deciding what constitutes ‘good’ ESG. What makes a difference in energy; initiatives with an environmental dimension will not be the same as in finance and insurance where governance is important, for example.
“For asset managers, the stewardship of assets will take on new impulsion,” adds Ms Goodall-Smith. “They will need to be very transparent with investors about what the firms they invest in are doing and show how and when they are engaging with the companies they invest in. They will also need to give investors choices over where to invest their money.”
Integration of ESG considerations
More than the metrics though, for investors the key change will be the integration of ESG considerations into everyday portfolios, as opposed to it being a standalone investment. In this way, everyone will invest taking ESG considerations into account in the same way that country and sectoral weighting are managed.
Climate risk and other, similar, issues will soon become very normal, standard things to look at when deciding whether to buy a company’s stock, says Harlin Singh, global head of sustainability at Citi Wealth. “Not taking action on these issues will harm a company’s profitability and make them less investable. For that reason, ESG will soon be less of a specific lens, rather, something that all companies will need to be looking at.”
Privately held companies too will need to take note. If they are to be successful over the long term, they need to take ESG seriously too, she adds.
She coins this as a move away from ‘exclusion’ based investment to instead including the companies that show best practices into a broader asset allocation strategy.
That said, there will also be room for investment strategies with specific themes. Much like philanthropy, investors will have their individual causes and preferences. So, specialist funds and investment strategies will not be disappearing entirely.
Ms Goodall-Smith too is hopeful about the future. “In five years, ESG will be seen as an integrated and transparent consideration in asset allocation. We won’t be talking about a specific lens or strategy anymore. In that sense, all investors will have an interest in ESG.”
