ESG strategies signal progress for people and the planet

Continued interest in environmental, social, and governance (ESG) issues is driving up global sustainable fund assets. According to data from Morningstar, inflows reached the highest-ever levels in the first quarter of 2021 for the fourth quarter in a row, with European sustainable funds dominating at around 80% of net inflows. While ESG investments still represent only a small portion of overall fund assets, by 2025, ESG funds are expected to outstrip traditional funds.

An ESG boom can partly be explained by ‘inelasticity’ in the market. This unresponsiveness to price changes is artificially pushing up returns.

Evaluating ESG investments is fraught with difficulty, from defining ESG criteria to understanding the true impact of individual assets. For example, in the 2021 Risk.net buy-side risk management survey, it was revealed that – at the cutting edge of ESG efforts – portfolio and risk managers struggle to measure and set limits on climate risk because of the lack or poor quality of the underlying data.

The dearth of depth and transparency in corporate disclosures is a serious impediment to the field. In particular, the lack of supply chain data makes it very difficult to measure the true sustainability of companies. Efforts by regulators to force disclosure of material exposures to climate risk, for example, have been delayed by opponents, but experts believe reporting initiatives, such as the International Sustainability Standards Board (ISSB), will lead to a global framework of consistent standardised corporate ESG disclosure.

Although there are some ESG criteria that are commonly agreed on in the industry – particularly for environmental aspects – not all ESG metrics are standardised. So how these criteria are weighted by ratings providers or asset managers will vary. The standardised metrics can sometimes be unhelpful in measuring sustainability, even at focal points such as carbon metrics. An analysis of the challenges in measuring ESG and climate transition risk also features in this report.

Some qualitative ESG criteria around corporate culture, for example, are not easily quantifiable. But experts are encouraged by the progress made towards materiality. For example, the Sustainability Accounting Standards Board has defined a core set of indicators using a materiality framework that carries over to the ISSB initiative.

One way asset managers can approach the challenge of meeting investor expectations is to ensure a fund complies with an independent ESG label such as the European Union’s Sustainable Financial Disclosure Regulation. There is no approval process for this, but the UK Financial Conduct Authority, for one, is exploring how to do this.

Methodologies that screen certain stocks are the easiest to communicate, but are not necessarily the most effective in making ESG progress. Investors have long been shifting away from negative screening and divestment to ESG integration. And industry experts see impact investing as a decisive approach towards measurable progress for people and the planet. At the heart of this report, these experts explore these and other developments in a roundtable Q&A, while the article by S&P Dow Jones Indices’ Jaspreet Duhra offers a timely discussion of the opportunities that emerged from the 2021 UN Climate Change Conference.

Finally, this report explores the challenges for issuers around liquidity and hedging of ESG structured products and derivatives.

 

ESG strategies – Special report 2021
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