Pressure on for fund managers to move to sustainable ESG models

The investing landscape is changing in very profound ways, and I worry that asset owners and asset managers are not catching up quickly to some of the drivers of change, especially when it comes to sustainability.

Environmental, Social and Governance (ESG) risks are now one of the largest threats facing businesses, and they could have a significant impact on their long-term performance and profitability, including their ability to raise new capital.

Interestingly, the balance of power to really influence sustainable investing rests with institutional investors, like pension funds, foundations, and endowments.

These are the people with the money that can really change the investment landscape, yet not much of sustainable investing is considered by fund managers and trustees, many of whom prefer investing in government securities.

This raises the questions; are the investment rules of today fit for purpose tomorrow? and do the investment model of asset owners and asset managers need fresh approaches?

We know that most investors when considering whether to invest in a company look at financial data: metrics like cash flow, sales growth, market share and valuation.

These are fundamental aspects of investment, but they are not enough. Investors should also look at extra-financial metrics encompassed under ESG.

This means understanding ESG in a capitalist context, that is, considering extra-financial information to enable better decisions that, if done properly, should lead to sustainable economic growth.

Sustainable investing incorporates financial factors alongside ESG factors into the investment process. It means limiting future risks by minimising harm to people and the planet and providing capital to users who deploy it towards productive and sustainable outcomes.

Therefore, sustainability matters financially today, and all signs indicate it will matter more tomorrow.

A 2022 survey by Stanford Graduate School of Business, which polled 2,470 investors with savings ranging from less than $10,000 to more than $500,000, revealed sharp differences along generational lines, with younger shareholders saying they are far more eager to have fund managers pursue ESG objectives and also far more willing to risk higher losses in the process; while those who are older and with low levels of savings, were largely opposed to ESG and unwilling to risk their assets to advance these objectives.

Further, while approximately two-thirds of millennial and Gen Z investors said they were very concerned about environmental and social issues like carbon emissions and income inequality, roughly two-thirds of investors of 58 years and older said they were only somewhat or not at all concerned.

This demonstrates that investors are not homogenous in their viewpoints on sustainable investing and significant divergence is based on age and wealth. It can be argued that younger investors are the ones who will have to bear more of the cost of an unsustainable world and that older investors have a shorter time horizon and that if they lose a bunch of money because their fund moves big-time into ESG, they won’t have much time to make it up.

The world’s largest asset management companies have come out swinging on sustainable investing, declaring their intention to use their proxy-voting power to press for everything from boardroom diversity to net-zero carbon emissions.

None of this is easy. But the pressure is on for asset managers to move toward the sustainable investing model, with the alternative of staying put threatening to expose the investment industry to vulnerabilities of decline.

Asset managers have a fiduciary duty to their clients and beneficiaries. It would therefore be necessary that their investment objectives be put into consideration.

Maybe it would be a smart move for a fund manager to poll the investors at a general meeting to see what they want, particularly where there’s a reasonable chance that tilting the investment strategy toward ESG would amount to a loss.

Sustainable investing will be key to supporting the transition to a greener and more sustainable future. In many ways, sustainable investing should be seen as part of the evolution of investing.

There is a growing recognition among industry participants that some ESG factors are economic factors, especially in the long term, and it is, therefore, important to incorporate material ESG factors in investment decisions.

With global advancements to develop a universal standard on sustainability, through the International Sustainability Standards Board, it is hoped that the challenges of conflating the landscape of ESG products and processes and greenwashing that currently spark frustration and confusion across the industry and among investors, firms, and policymakers will be addressed.

In the meantime, interest in sustainable investing continues to grow, and asset owners and managers must prepare to tackle emerging issues, including conflicting investor objectives to risk and return.

Sustainable investing will remain a potential bright spot in an era where the investment industry is being challenged by rising client expectations and a challenging economic outlook.

Although the future of sustainable investing includes many unknowns, the next stage of its development will depend heavily on industry leadership and innovation in investment thinking, rulemaking, practice, and data management.

Ms Wangui, Managing Partner and ESG Lead at Protos Capital LLP.