The field of environmental, social, and governance (ESG) investing has undergone rapid changes in recent years. Below, we share five trends we’re seeing in the space, and what they mean for investors.
Trend 1: Investors are moving from purely exclusionary to integrated ESG strategies
For decades, asset owners have used exclusionary strategies to keep securities that did not align with their values out of their portfolios. Increasingly, we see investors embrace ESG investing due to the “value” it offers to long-term investors. Investors are looking at ESG factors not as separate considerations, but as complementary data to be integrated alongside traditional financial information.
Three reasons are behind this trend:
- The proliferation of ESG data providers in the 2000s means that by now more historical ESG data is available for research, which increasingly shows that material ESG information can be a value driver to be considered in the investment processes
- The development of market infrastructure such as the Sustainability Accounting Standards Board (SASB) Framework has encouraged companies to report their ESG activities in ways that are material to investors
- Regulatory action, particularly in Europe, will mandate investors to consider ESG information in their investment process1
It is important to note that exclusions and integration are not mutually exclusive approaches to ESG investing, and exclusionary screens are often an overlay in an integrated approach. This allows investors to build ESG portfolios that closely align with their objectives.
Trend 2: Investment strategies will be increasingly powered by multiple sources of ESG data
Historically, investors have been reliant on a single source of ESG data to inform their investment processes. This data typically comes from third-party providers. Most providers employ their own proprietary methodologies, and recent research by State Street Global Advisors shows that there is often low correlation between how different data providers score the same universe of companies.2 Therefore, choosing a data provider also means choosing that provider’s ESG investment philosophy.In response, we increasingly see investors embracing investment solutions that are based on multiple providers. For example, some investment consultants are starting to favor investment strategies that are informed by multiple sources of ESG data. We expect this to become increasingly common across the industry in the coming years.
Trend 3: Growing demand to understand ESG performance of the portfolio against desired objectives will drive the need for enhanced reporting
With investors looking at ESG as a value-based dimension of their portfolio, they increasingly want to understand ESG performance the same way they would any other traditional financial measure.
This, along with demand from beneficiaries and stakeholders for greater insight into the ESG profile of their investments, is leading to greater interest in robust ESG reporting along dimensions such as carbon intensity, controversy exposure, and overall ESG profile.
Trend 4: Climate solutions will evolve to include adaptation alongside mitigation
For asset owners who seek to invest in a way that is aware of and responsive to climate change, solutions in the marketplace have traditionally focused on mitigation: reducing the effects of climate change on a portfolio by, for example, reducing exposure to greenhouse gases and increasing exposure to “green” energy companies.
As extreme weather events become more frequent and the economic impacts of climate change more widely understood and accepted3, investors will require companies to disclose how they are adapting their business strategies to accommodate the impacts of climate change. This is particularly true of those investors who are committed to the Task Force on Climate-related Financial Disclosures (TCFD). Consequently, management and boards will need to fully incorporate climate change into their long-term strategies. Investors on the leading edge of climate investing will seek to enhance their climate investment from pure mitigation strategies to those that align to a mitigation and adaptation investment thesis.
Trend 5: Mainstreaming of ESG will drive investments in talent and infrastructure
ESG investing no longer lives in a silo as it once did. Increasingly, ESG is being integrated into the routine investment processes of asset managers. Because of this, the demand for experienced ESG professionals is acute. ESG investing is a specialized field that requires interdisciplinary knowledge and a variety of capabilities –deep investment expertise, strong policy and strategic analysis, and the ability to communicate to stakeholders who often use differing ESG-related terminology.
To build robust ESG capabilities, firms will require talent that can do each of these things well. It also will require training of current investment and sales teams, as well as investments in data, analytics and reporting infrastructure to allow for full integration.