Tuesday 24 August 2021 11:08 am CFA Institute Talk

ESG: full speed ahead, sat-nav still required

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These are articles written by professionals for investment professionals. They are contributions from external subject matter experts who do not work for CFA Institute, but may be a CFA charterholder as well as a member of a CFA Society. All are experts in their field and strive to deliver useful insights that help investment professionals make better decisions.

Sustainable investing based on environmental, social and governance (ESG) factors has become central to how we invest.

Investors are demanding more from their asset managers: they want to invest based on their values and they are demanding more accountability from companies about addressing changing societal issues.

Indeed, the Index Industry Association (IIA)’s most current latest Annual Benchmark Survey found that the number of ESG indexes had increased by 40 per cent in the past year in response to growing investor demand.

Once just a niche investment strategy and policy, sustainable investing has taken the helm in navigating global investment trends. The asset managers responsible for the composition and management of global ESG portfolios are, by definition, determining which companies meet ESG standards for investment.

Dizzying array of data

But investors want more answers. They want to know what’s needed to take ESG investing to the next level. Who sets ESG standards and how are they measured for companies that are evaluated globally? How do asset managers determine which companies meet these standards and warrant inclusion in investment portfolios? Or, conversely, how do they decide which companies lack the ESG credentials necessary for inclusion?

To better understand the major challenges and opportunities in the ESG market, the IIA set out to assess how asset managers perceive ESG investing.

A survey was commissioned in early 2021 of 300 asset management companies in four major economies — the United Kingdom, France, Germany and the United States (the country in which the IIA is headquartered).

On a basic level, the survey findings confirmed some of the more obvious trends in ESG investing. Without a doubt, ESG is a very high priority for global asset managers and will likely remain so in the decade to come.

Eighty-five per cent of respondents said that ESG is a primary concern for their companies. They expect the level of portfolio investment in ESG to rise considerably in the coming years, with the proportion of ESG assets increasing from 26.7% in 12 months to 43.6% in five years. And this rapid growth isn’t happening in a vacuum. It is being fueled by growing global demand for more ESG-friendly investments.

Priority of ESG within Your Company’s Overall Investment Offering or Strategy

While there are differences across countries, the results confirm ESG is a ‘big deal’ and very much on the minds of global asset managers as they formulate investment strategy and allocate resources. This is good information to know, but not exactly groundbreaking.

Once we started digging deeper into the thinking of asset managers, we came to understand more about the real challenges — as well as opportunities — for ESG investing.

The first challenge that rang through loud and clear has to do with data. High-quality data on ESG corporate performance is critical, yet ESG measurement is still an evolving and imperfect science. Our survey showed that beneath the growing excitement and adoption around ESG approaches, there are still major gaps in the quantity and quality of the ESG information available to investors.

Sixty-three per cent of the asset managers surveyed identified a lack of quantitative data as a major (24%) or moderate (39%) challenge to ESG implementation. And 64% cited a lack of transparency or insufficient corporate disclosure around a firm’s ESG activities as another hindrance.

To What Extent Are the Following Aspects a Challenge to ESG Implementation for Fund and Asset Management?

And this issue goes beyond data. Our survey underscored the fact that there is no common global consensus on how ESG performance should be defined and measured.

This is not due to a shortage of actual ESG metrics. A dizzying array of market data providers and industry boards each have their own approach to measuring ESG. Often, different providers have polar opposite takes on a single stock, and industry watchers and the news media have not hesitated to highlight these conflicting reports.

Mandating consistent guidelines and frameworks for the rapidly growing ESG investment world is another, related challenge.

Impact of Regulation

While the survey indicates that global asset managers largely trust regulators to push standards in this space, they also see little consistency across markets and regulatory regimes. Fifty-six per cent of respondents say they are finding it difficult to keep up with ESG regulations; 65% say regulators need to pay more attention to the asset management industry’s views on ESG issues; and 78% agree that we will see additional ESG regulation of the asset management industry during the next few years.

‘ESG’ itself is evolving

So, where do we go from here? What makes this area so fascinating is how it is still so quickly evolving and software updates to ESG’s metaphoric global positioning system (GPS) will be necessary.

Even the very concept of ESG is evolving. Historically, the ‘E’ and ‘G’ of ESG have been fairly well addressed, but the ‘S’ factor remains very much a work in progress. Society is undergoing rapid changes and these changes are not viewed with the same lens in all countries and regions. Flexible standards that can incorporate these differences will be key to the future of ESG growth.

Market indexes have done a good job to stay on top of ESG industry developments and design index measurement tools to help investors evaluate ESG markets and issuers and to better implement their investment strategies. Better corporate data will enable better ESG benchmarks, which will allow asset managers to better invest in ESG mandates from investors.

The IIA’s survey of asset managers supports this point but, importantly, underscores that we still need a more accurate GPS.

This is the fourth installment of a series from the Index Industry Association (IIA).

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By Rick Redding, CFA, chief executive officer at Index Industry Association (IIA), the first-ever trade group for independent index providers globally.

All posts are the opinion of the author. As such, they should not be construed as investment advice, nor do the opinions expressed necessarily reflect the views of CFA Institute or the author’s employer.

Image credit: ©Getty Images/Lars Schneider