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ESG makeover for investment industry

David Smith  |  09 Mar 2020Text size  Decrease  Increase  |  
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As investors move with a sense of urgency into a new decade, we identify five environmental, social and governance (ESG) trends that we believe will redefine investing in the years ahead.

Some expand on emerging themes, others strike out in new directions. But all promise to shape the behaviour of corporates and their principal investors: asset management firms and institutions.

The overarching driver behind these trends is growing global concern about ESG issues. This will propel ESG investing further, from the fringes of the asset management industry to its mainstream.

Increasing demand for disclosure, data and information will compel asset managers to integrate ESG analysis more explicitly into their due diligence and portfolio construction processes. For some it will require a major shift.

smoke billowing from coal-fired power station

A higher awareness of the environmental impact of companies and industries is tipped to accelerate investment into renewable energy, and divestment from firms that deal in fossil fuels 

Whether driven by societal expectations or recognition that ESG analysis can add meaningfully to returns, these trends promise to enhance engagement between companies and their investors. That would be a major plus for the sustainability of both investment portfolios and the planet.

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Here we outline the five ESG trends that we believe will reshape investing in the coming years.

Environmental impact

Severe weather phenomena such as cyclones, hurricanes, floods and fires have infused global news coverage and social media over the past year. With climate change forecast to heighten the intensity of weather events further in future, it will become crucial for corporates, institutional investors and asset management companies to answer two key questions: 1) how does my business/investment impact the environment? and 2) how does the environment impact my business/investment?

This will likely accelerate investment into renewable energy, and divestment from firms that deal in fossil fuels. It could also sharpen investors’ focus on the resilience of infrastructure – roads, railways, ports and airports – to climate change, prompting a shift in the composition of investment portfolios.

Mainstream integration

While interest in ESG investing has developed in recent years, asset managers and institutional investors adopt different approaches. Some purchase ESG data from third-party providers to help inform portfolio decision-making, while others hire ESG analysts to engage companies only after they’ve bought them, or outsource ESG capabilities entirely to an external party.

But as the narrative shifts from “how much does ESG cost” to “how do we do this”, increasingly asset managers will look to embed ESG capabilities into their own teams to strengthen their pre-investment due diligence. This will drive the mainstreaming of ESG integration over the next two years in recognition of the value it can bring in safeguarding the sustained success of portfolio companies.

Data drive

We expect to see a meaningful improvement in the quality and consistency of ESG data. We anticipate that stock exchanges and regulators will strengthen disclosure requirements. That will compel corporates to improve the breadth and granularity of information they provide.

We also expect to see investors push ESG data providers to improve their coverage of companies and consistency of their methodology. Investor demand will compel them to provide less, but more meaningful data. At the same time we anticipate a shift from quantitative to qualitative data. Investors will want more than basic data points. They will want to understand the sustainability of companies’ strategies and the improvements these firms could make to enhance their value. The ESG data industry has evolved from one fixated on screening and tolerance limits. In future it will need to focus more on performance.

Corporate profitability

Even now some companies regard ESG as more of a public relations activity than a business imperative. That will change as they come to view factors such as corporate disclosure and resilience to climate change as essential to the sustainability of their business. Management teams will need to know, and be able to demonstrate to their boards of directors and investors, how their business models will remain valid in 10 years’ time.

To do that they will need to identify and guard against ESG issues that could cause disruption, from data breaches to supply-chain risks to discontent among staff that prompts turnover of key personnel and loss of knowhow. The game-changer will be seeing ESG as a means not only to manage risk, but also to drive returns. Firms able to showcase how they safeguard customer data, prioritise environmental sustainability, foster a good staff culture and maintain standards among their supply chain will resonate with consumers. That will drive profitability, and consequently investor interest.

Defined mandates

ESG-related questions that institutional investors have directed at their asset management partners traditionally have centred on stock selection and portfolio construction. Increasingly we believe institutions will define ESG parameters that fund houses must adhere to in managing portfolios.

We expect to see a marked increase in such mandates over the next few years. While they will feature traditional performance requirements, mandates may also require investment partners to work within a carbon budget; or manage a portfolio of companies that achieve a minimum ESG score; or build a portfolio with quantified environmental or societal impacts. While this is under way in parts of Europe, growing concern about ESG issues among governments and societies more broadly will dictate that it accelerates across Asia and the rest of the world in the next few years.

, Head of Corporate Governance – Asia Pacific, Aberdeen Standard Investments

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