ESG investing – a priority when building back better?
26 June 2020: Investment owners have shown increasing concern for the social responsibility of their investments but is this a priority in a crisis? Siobhan Stewart, ESG Consultant at Sillion, comments.
Pride before a fall?
The rise of ESG as a focus of corporate and investor interest was on a steady and gentle trajectory, that is until it hit an inflection point around 18 months ago.
This sudden popularity in ESG funds was met with moderate scepticism from some of the investment community. Cynics argued that this surge in ESG effort and sophistication was a temporary anomaly in a benevolent market, an indulgence at the end of a ten-year bull-run. History is on their side. The 2008/09 crash saw investors demote climate change to the bottom of their priority list. Just wait for another recession, the naysayers said, then we will see who really cares about what. And here we are.
COVID-19: the acid test
Now ESG investing faces its first real acid test. This year we watched as faith in the financial markets crumbled, with global equity benchmarks falling from their record highs. The market-wide circuit breaker at the New York Stock Exchange was triggered for the first time since 1997, and then a further three times.
So how has ESG faired? While the pandemic is far from over, the early data indicates that cynics might be given a run for their money. ESG funds saw global inflows of $45.6 billion in Q1, compared with outflows of $384.7 billion for the overall fund universe. An FT and Savanta UK poll found that almost 9 in 10 wealth managers polled believed that COVID-19 would result in increased investor interest in ESG.
Asset allocators, for now at least, seem willing to stick with their ESG investments. Some have even been rewarded for their decision. More than half of the ethical investment funds have outperformed the wider global stock index. The MSCI World Stock index fell by 14.5% in March, but 62% of ESG large-cap equity funds outperformed the global tracker.
However, these are only early signals. It won’t be until the dust settles that we can really tease out the reasons behind fund performance and resilience. In the meantime, are there other indicators we can use to infer if ESG is here to stay?
Structural drivers
What, in addition to the performance of ESG funds, has changed to push traditionally conservative asset managers towards integrating sustainability into their investment decisions?
Of course, we have mounting regulatory pressure, as well as an ecosystem of reporting frameworks that make comparative ESG analysis more plausible; but the most significant factor is that asset owners (for example pension funds) are now asking too.
Asset owners don’t just want more information on how ESG is being considered, but also have more stringent requirements for allocation of capital. As a result, ESG has become a necessary precursor to securing a wide range of investment mandates. Whether they care about sustainability or not, the decision to engage with it is increasingly being taken out of the hands of portfolio managers.
Is this going to change? It doesn’t look like it.
Asset owners are not suggesting that a pandemic was the exact risk which they were worried about, but they are seeing it as an extremely good example of colossal financial risk hidden from the markets. ESG, with its potential to identify structural problems in a corporate’s business model, can help to uncover these hidden risks.
What does this mean for corporates and the accountancy profession?
The cascading influence of asset owners doesn’t stop at asset managers. It kicks down from them to corporates.
Traditionally, the route for ESG practices to permeate a plc has been through the sustainability department. However ESG is now arriving to the investor relations team, with real implications for a corporate’s cost of capital. It is no longer a CSR problem, it’s an issue for the CFO.
This change is reflected in the mounting focus on the flow of ESG information between investors and corporates, in particular ESG reports and the frameworks that lend shape to these disclosures. Investors are demanding high quality ESG information on which to report themselves and base their decisions.
However, an alphabet soup of acronyms awaits corporates looking to disclose. In response, a number of high-profile projects, including that of the International Business Council and Accountancy Europe have been launched to standardise the set of non-financial metrics companies can use. The accountancy profession is taking an increasingly prominent role in these ventures.
Some have voiced their concerns over premature standardisation. This is in light of both the technical challenges of standardising environmental and social metrics and the limited evidence that sustainability disclosures have driven concurrent improvements in sustainable practices.
These challenges strengthen the assertion that now more than ever, measuring what matters and holding those who report to account is vital to progress. If we are to build back better the profession must be ready to respond, so all of us, from consumers to investors can make better, more holistic decisions.