With environmental, social, and governance (ESG) issues having set off a dramatic and continuing shift in the asset and wealth management (AWM) industry, we wanted to find out how institutional investors and asset managers are responding—and how they see the market evolving in the years ahead.
One of the most striking findings from our survey, explored in the report Asset and wealth management revolution 2022: Exponential expectations for ESG, is the extent to which the surge in demand for ESG funds is a global phenomenon, rather than just being confined to Europe (as previous studies have shown). In the US, for example, more than eight out of ten institutional investors (81%) plan to increase their allocations to ESG products over the next two years, almost on a par with Europe (83.6%). The rise in demand in other regions is close behind, most notably in Asia-Pacific—albeit from a lower base than that of the US or Europe.
Why is the shift in allocations accelerating? Clearly, the investor focus on sustainability and social inclusion has increased in recent years, especially in the wake of covid-19. Our survey also highlights a growing belief within the investor community that ESG performance and financial returns, rather than conflicting, in fact go hand in hand. Six out of ten institutional investors are already recording higher yields on their ESG investments compared to those that are non-ESG. Most asset managers concur: nine out of ten are convinced that integrating ESG products into their investment strategy will improve overall returns in the long term.
Powerful engine of growth
The surge in demand for ESG funds is even more significant when set against the backdrop of the uncertainty and contraction in financial markets. Asset managers can no longer rely on rises in asset prices to sustain the growth in fee income and assets under management (AuM) seen during much of the past decade. Under our base-case economic scenario, we project that overall global AuM will increase by a compound annual growth rate (CAGR) of just 4.3% between now and 2026, less than half of the 8.9% CAGR achieved between 2016 and 2021.
Our survey highlights a growing belief within the investor community that ESG performance and financial returns, rather than conflicting, in fact go hand in hand.
ESG funds are one of the few bright spots, helping to offset dips elsewhere. At 12.9%, ESG’s CAGR will easily outstrip the market as a whole to reach US$33.9 trillion by 2026, at which point ESG funds will account for more than one-fifth of global AuM (21.5%, compared to 14.4% in 2021).
With ESG AuM growing, asset managers can in turn bring more of their weight to bear in tackling inequality and driving green transition. The result would be a virtuous circle of purpose, opportunity, and sustainable growth.
Opportunities, challenges, and trade-offs
With expansion comes challenges, however. As our report highlights, the primary focus for most asset managers is retrofitting existing funds to keep up with investor demand. Less than half have immediate plans to launch new ESG funds. This creates openings. By accelerating new product development and actively supporting green transition, the front-runners can sharpen innovation, boost relevance, and seize market share.
The scramble to convert existing funds could also heighten concerns over whether some products aren’t sufficiently ESG-focused and hence are potentially mislabeled. Mislabeling is rarely intentional—more often than not, it stems from a lack of clarity in regulatory designations on ESG offerings. This can be compounded by inconsistent data standards and poor information coming from portfolio companies. Nonetheless, it remains a significant risk amid the backlash against “greenwashing.” So if mislabeling does occur, it’s important to be prepared. This includes being able to quickly explain why and move swiftly to correct and learn from any mistakes.
Further questions center on timing. In particular, the impact of the war in Ukraine on energy supply, security, and prices has raised questions among some investors, asset managers, and portfolio companies over whether the green transition may need to be modified in the short term. Nonetheless, the longer-term intentions on ESG allocations are clear from our survey.
Rethinking how value is defined and delivered
Looking ahead, the ESG funds market and the purpose-led opportunities within it will continue to open up. Key developments include the enlargement of the investible universe as more businesses embrace ESG transition. This would allow asset managers to invest in companies that aren’t sustainable now and then help them with the finance and expertise needed to incorporate positive ESG outcomes into their strategies and operations.
When combined with the continuing shifts in investor expectations, these new fund frontiers are set to transform how value is defined and delivered in the AWM industry. In our Exponential expectations for ESG report, we look at how asset managers can get up to speed. The first step is a move away from a focus on ESG-oriented investment toward integrating ESG principles into the heart of the asset manager’s purpose, strategy, and investment management. This in turn demands a clear vision of what the business stands for; a road map for change; and a durable governance, accountability, and reporting framework to make sure that what is being promised is being delivered.
Much of this ability to deliver hinges on the quality and reliability of the information used regarding decision-making and disclosures. Although its volume is increasing, the available data lacks breadth and consistency. Overcoming these deficiencies is likely to require an overhaul of data, systems, and reporting processes.
None of this is easy. It will also require significant investment. But the quicker and more wholeheartedly asset managers embrace, embed, and operationalize ESG considerations, the better their ability to attract capital and deliver on their purpose and potential.