ESG, Environmentalism, Responsible Investing, Sustainability, and the myriad of associated acronyms, which are only increasing after the COP26 UN International Climate Conference, can make it complicated to understand the ESG landscape. It can be useful to look at the bigger picture, and in doing so one is led to the conclusion that despite the complex and systemic nature of solving the many challenges within ESG, the tectonic plates are shifting to ensure that in 2021 ESG has become mainstream.
Unsurprisingly, within the ESG investment approach, there is considerable focus on climate, simply because this is the biggest and most immediate problem. As an investment advisor, we help investors to structure, manage and control their investments, thereby meeting a wide range of fund managers and products for private investors. While fund managers have been, and continue to be criticised for facilitating investment into fossil fuel-based investments, the truth on the ground is that, as an industry, they have made huge strides in the past three years to incorporate ESG principles into specific products. In doing so, they demonstrate their deep thinking about how to identify the emerging innovations that will support the transition from a brown to a green economy and how to avoid the resulting risks. The industry is well ahead of the regulators in this regard. Most major investment managers now have firm-wide sustainable investment approaches, realising that the risks and opportunities will apply to their entire portfolios
In general, regulators have been behind the curve. Companies are innovating and providing investment opportunities well ahead of the regulatory environment. Investment risks from stranded assets will be evident when the regulators catch up. Forward thinking companies are pushing the regulators to create a level playing field when they compete against companies who pollute and extract with no regulation or cost. While the regulators have taken some first steps, membership organisations such as the UN PRI and the newly created ISSB are leading the charge.
But the problem is that these approaches are not consistent with one another or internationally, and it is questionable to what extent they have teeth.
Investor surveys demonstrate that there is a clear appetite for doing good with their investments. It is interesting to note that asset owners are nevertheless still some way behind, with demand not keeping up with the range of products on offer. Explanations for low ESG related portfolio take up include “Clients have not raised this” and “too much risk of intergenerational disputes”. There are also concerns about the impact on investment returns or approaches that curiously treat ESG like a diversification strategy by allocating 5-20% to the area. Our approach as investment advisors is that investors are either in or out. We believe that owners are catching up as they increasingly realise that there are significant risks to investment returns and reputations in not properly addressing ESG. It is no longer a tick box exercise to feel good. Moreover, there is a risk of missing out on investment opportunity in a time of major disruption and exposure to exogenous factors that are as yet difficult to discern (such as carbon tax, orphan assets, waste and plastic taxes).
ESG performance and impact
Perhaps the largest drag to acceptance of ESG investment principles, has been the belief that by constraining your investment environment, investment performance will suffer. This used to be true but there is increasing evidence that, looking forward, this is no longer the case and having an ESG component will be positive simply because of the weight of money. As with any investment opportunity there is a risk of over-paying but this should not be conflated with the investment being ESG.
As the ESG ecosystem evolves, momentum in the system will be with those players that link all the elements together. As investment advisors, we help the client define their requirements within a flexible Sustainable Investment Framework. ESG is our default position, from which you have to opt out. The approach ensures you have a proper conversation about ESG investing at the outset. The range of fund manager approaches to the topic are then taken into consideration as an essential part of a diversified portfolio structure.
For these reasons, our view is that ESG is not a passing fashion, 2021 has seen it become mainstream. In its almost existential complexity, it presents opportunities and risks, with the challenge moving forward, for professional service providers, is how to articulate these to your clients and provide a practical framework within which they can be managed.
Managing Director, IAM Advisory
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