Over the past few years, changes in demographics, legislation, and the ways data is acquired and processed have shifted how huge institutional investors determine how and where to distribute their funds.
Investors are increasingly interested in “responsible investment” – sustainable and ESG (environmental, social, and governance) – to ensure that their money is put to good use. Activity has been steadily increasing, according to the United Nations’ Principles for Responsible Investment.
2020 will most likely be remembered as the year in which COVID-19 advanced the trend toward responsible investing. As sustainable businesses outperformed their traditional peers, ESG integration became widely recognized as a driver of investment returns. As a result of the increase of sustainable issuance, more investors are entering the market and the investable universe is expanding. But what comes after that?
The growth of responsible investment is being fueled by a number of factors, including:
Materiality
In the financial industry and academia, there is a growing acknowledgment that environmental, social, and governance (ESG) factors influence investment returns. ESG integration is the process of explicitly and systematically considering ESG issues in investing research and choices in order to better manage risks and boost returns.
Demand from clients
Clients and beneficiaries are increasingly demanding more information about how and where their money is invested. This is due to a greater understanding of how ESG variables affect corporate value, returns, and reputation, as well as a growing focus on the environmental and social implications of the companies in which they invest. The most common way of integrating values in a portfolio or fund is negative screening, which excludes specific sectors, firms, or behaviors.
Regulation
Responsible investment regulation has grown dramatically since the mid-1990s, with a recent spike in policy interventions following the 2008 financial crisis. National and international regulators have realized that the financial sector may play an essential role in addressing global concerns such as climate change, modern slavery, and tax evasion, which has prompted regulatory change.
Here are some of the most important trends we’ve noticed.
Clients will Place a Greater Emphasis on Funding True Impact
“How can we ensure that the money we invest in financial markets has a good influence on society?”
In the coming years, this will be one of the leading questions for clients. COVID-19 prompted them to pay even greater attention to the basic concerns that affect human life around the world. Green bonds, sustainable equity strategies, and other products that allow clients to directly contribute to environmental or societal change are in high demand. Investors also want greater information on the impact of their holdings. This tendency is only going to increase.
Investors Will Become Increasingly Aware of the Critical Need for Climate Action
The United Nations Climate Change Conference in 2021 will heighten the sense of urgency in addressing climate change challenges. Images of pure blue sky during the pandemic’s early stages inspired people, so I believe governments will be under even more pressure to scale up their efforts. It is critical for investors to adopt a wide picture of climate change. Companies will encounter social difficulties related to job security and the skills gap as they migrate to a more climate-friendly business model. Long-term investors must remain committed to firms and assist them as they make difficult but important decisions. We must also pay the change if we urge them to change.
We anticipate asset managers adjusting their policies in the future to take this into consideration more.
Cross-National Collaboration on Certain Topics Will Become More Common
In order to influence change through involvement and debate, asset managers will increasingly join cross-industry coalitions.” Europe is leading the way on this, but the United States is also taking steps in this direction. Investors can have a greater impact on concrete themes that reflect clients’ preferences by collaborating with social and governmental organizations. Our signing of investor statements to halt deforestation in Indonesia and Brazil is a fantastic example from 2020. We hope to work with many more coalitions in the future to further our sustainable agenda. We’re keeping a careful eye on developments surrounding the Taskforce on Nature-Related Financial Disclosures’ debut. This is related to the growing importance of biodiversity, a topic with which we already collaborate with organizations like the WWF and MVO Nederland. We encouraged world leaders in 2020 to agree on concrete actions to reverse nature loss in the coming decade in order to preserve ecosystem resilience.
Investors Will Use More Tools to Influence Companies
ESG will become an intrinsic aspect of asset managers’ stewardship role.” Investors have had a difficult time using voting to impact ESG regulations in the past, but that is about to change. We expect the first corporations to allow investors to vote on their sustainability policies at their annual general meetings in the coming years. Companies will begin including a ‘say on climate’ or a ‘say on diversity’ as a routine item on the AGM agenda, similar to the ‘say on pay.’ Through engagement, investors will have additional opportunities to influence ESG regulations.
The Industry Will Be Reshaped as a Result Of Regulatory Intervention.
In the industry, regulatory action will be a primary driving force. Investors will be required to demonstrate how they integrate ESG and how their investments contribute to long-term change under the EU’s new Sustainable Finance Action Plan. For the time being, this trend will mostly affect European companies, but it will also harm companies worldwide as European investors demand more transparency from their global investments. Clients will profit since it will be easy to compare products and have a better understanding of how their money is spent. Furthermore, we anticipate asset managers introducing more investment products that allow clients to participate directly in good change.
Misconceptions About Responsible Investing
The responsible investment sector is fast evolving, leading to misunderstandings about what it involves, such as:
…it entails putting money into a certain investment strategy or product.
It is not necessary to invest in a specific strategy or product to be considered responsible. It involves incorporating ESG data into investment decision-making and stewardship techniques to guarantee that all relevant factors are included when evaluating risk and return. The manner in which an investor engages in responsible investing differs greatly.
…it leads to reduced investment returns.
Responsible investing does not need a reduction in returns; in fact, it should improve risk and return characteristics. Investors use a variety of strategies to detect dangers and opportunities that would otherwise go unnoticed if specific ESG data and broad ESG trends were not examined.
…the terms sustainable, ethical, socially responsible, and impact investing are interchangeable.
The multiplicity of investment approaches that incorporate environmental, social, and governance issues are referred to by a variety of labels. There are no formal definitions for most of them, and they are frequently used interchangeably. Whereas many people make moral or ethical ideals their primary goal, responsible investment may and should be followed by the investor whose sole goal is to gain money.
In Closing
Investors are increasingly demanding solutions that cover all aspects of an ESG portfolio, so sustainability is at the heart of all investment areas. However, until the ESG portfolio is complete, there are still certain gaps to fill, which is where intelligent innovation comes in. For asset managers, this means that sustainable investment should be a key component of product development that meets investors’ goals.