The year 2019 was one of cataclysmic fire and rain. Wildfires swept across California, the Amazon, and Australia, and storms and floods deluged parts of six continents — a string of natural disasters that scientists say were caused by the changing climate. And in 2020, the COVID-19 pandemic has coursed through the world.
Historically, events like these — along with other concerns that are included in what Wall Street calls environmental, social, and governance (ESG) issues — haven’t been a major business concern for most asset and wealth management (AWM) firms. As recently as 2016, only 10 percent of AWM CEOs counted themselves as “extremely concerned” that climate change could threaten their business’s growth, according to PwC’s CEO Survey. But that’s changing. In the 23rd Annual Global CEO Survey, which was released in January 2020, that share rose to 25 percent, and 62 percent of AWM CEOs expressed some level of concern about the climate. They were similarly worried about income inequality and social instability. Now, in response to the coronavirus pandemic, a PwC survey of chief financial officers shows that as of April 6, 73 percent of respondents believed the outbreak could have a significant impact on their business operations.
In January 2020, the world’s largest asset manager, BlackRock, announced in a letter to clients that it would place sustainability, particularly with respect to global warming, at the center of how it “manages risk, constructs portfolios, designs products, and engages with companies.” The company’s goal, ultimately, is to supplant its portfolio of passively managed funds with sustainable alternatives; reduce ESG risks in its actively managed assets, including by divesting from coal production; and push portfolio companies to completely disclose how they are managing these risks.
Of course, many smaller investment firms specialize in sustainable investment, and most of the trillion-dollar investment managers also offer some ESG-driven products. Last June, France’s Crédit Agricole announced (pdf) its intention to fully withdraw from financing coal power and shift investment capital to clean energy sources, including through its US$1.6 trillion asset management subsidiary Amundi. But should BlackRock fully implement this ESG strategy across the $7 trillion in assets it manages, it would set a new standard for the industry.
What’s driving this strengthened commitment to ESG? To be sure, climate activism is surging. Swedish student–activist Greta Thunberg and her confederates around the world have captured much of the attention, but various other campaigns have also put pressure on asset managers.
Environmental groups that had targeted BlackRock because of its investments in fossil fuel producers and because it refused to pressure portfolio companies on climate action and transparency took some credit for the company’s course correction. Meanwhile, other large institutions are finding themselves in the crosshairs. In the U.S., a coalition of environmental groups branding itself as Stop the Money Pipeline is putting pressure on JPMorgan Chase (one of the world’s largest lenders to the fossil fuel industry) and Liberty Mutual (a leading investor in and insurer of fossil fuel production). Across the Atlantic, charity ShareAction is organizing Barclays shareholders to request that the company align its lending with the Paris Climate Accord by withdrawing financing for fossil fuel projects. And the U.K. group Extinction Rebellion has held stunning protests at the headquarters of financial institutions around the world, both public and private.
But whatever attention these campaigns generate, it’s likely that investors themselves are the ones most effectively carrying the message that ESG issues matter. In 2019, PwC conducted a global survey on the investment priorities of 750 institutional investors and 10,000 retail investors, and found that overall, ESG concerns ranked third, below risk–return but above several aspects of service in which investment managers typically compete for customers, such as fees, relationships, and operational capacity. The strong showing by ESG factors was driven primarily by institutional investors.
[In a survey of investors,] environmental, social, and governance concerns ranked third, below risk–return but above several aspects of service in which investment managers typically compete.
Investment statistics reflect this shifting mind-set. In the developed world, at least $30.7 trillion worth of assets were invested sustainably in 2018, up about one-third since just 2016, according to figures compiled by the Global Sustainable Investment Alliance. This transformation has occurred particularly rapidly in Australia, New Zealand, and especially Japan, where growth in sustainably invested assets averaged 308 percent a year between 2014 and 2018. In the U.S., about $1 in every $4 invested through professional managers was guided by ESG principles in 2018, according to U.S. SIF (pdf), a group that advances sustainable, responsible, and impact investing. That amounts to about $12 trillion and represents an increase from about $1 of every $8 in 2010.
In Europe, where ESG issues have been most fully embraced, sustainable priorities have now found their way into law. The European Union’s 2018 Action Plan on Financing Sustainable Growth aims to better manage the financial risks stemming from climate change, resource depletion, environmental degradation, and social issues, and to foster transparency and long-term thinking.
PwC’s CEO Survey suggests that even if many AWM CEOs appreciate the threat that climate change poses to their business, they are less likely to fully understand the opportunities it presents. Only a little more than half of survey respondents agree — and only 16 percent strongly agree — that initiatives designed to combat global warming will offer big opportunities to roll out new products or services. Asset managers seem to think the biggest benefit their firms will reap from such initiatives is a reputational advantage.
Managers might be underestimating their customers’ commitment to ESG goals. Investors choosing ESG priorities aren’t just assuaging their conscience or signaling their virtue — they’re also chasing the bottom line. MSCI, a leading developer of benchmark indexes across a vast range of financial products and markets, points out on its website (pdf) that studies have found “meaningful links between company ESG characteristics and financial performance. This research has demonstrated that ESG considerations have affected the valuation and performance of companies, including with respect to their cost of capital and profitability.”
In January 2020, MSCI urged investors and asset managers to essentially follow the market’s lead. “If you are an investment institution and you’re not embracing this and taking it into account, it’s going to be at your own peril,” MSCI chair and CEO Henry Fernandez said on CNBC. “Your portfolios are going to underperform dramatically because there’s a common repricing and common reallocation of assets around the world according to the ESG criteria.” Before May 2020, MSCI will publicly release ESG ratings for all its stock indexes and for the most popular mutual funds.
The conventions of ESG are well enough established that embracing them should hardly require a leap into the dark. Here are just a few imperatives firms will need to consider as they work to incorporate ESG considerations.
Become advocates. As with almost any other major company initiative, the board and senior management need to champion sustainability to ensure that ESG projects get the resources and attention they need to succeed.
Decide on the firm’s strategic positioning. Investment managers will have to decide whether to implement ESG considerations across all the firm’s activities or limit them, at least at first, to discrete funds or lines of businesses.
Take a “values” approach. Asset managers tend to combine several approaches. So-called values approaches often prioritize the investors’ principles over financial return. Many asset managers leverage their equity stakes to press the management of portfolio companies on their ESG policies — asking company officials to study these issues, disclose more information about them, and improve those practices that are affected by them. The approach often begins by attempting to talk directly with executives; if that fails, activist asset managers often turn to shareholder resolutions.
And/or take a “value” approach. There are different ways of using ESG criteria to analyze investments and construct portfolios — a process also known as ESG integration. Asset managers might:
• Screen projects, companies, or sectors, either to exclude those with the biggest environmental or social impacts (negative screening) or to invest in the ones with the best ESG performance (positive screening).
• Adopt sustainability-themed investments (such as affordable housing or solar panels to mitigate climate change) to help finance sectors or companies that are attempting to solve specific ESG problems.
• Favor impact investments to generate positive social or environmental change, making profits a secondary concern.
According to the U.N.'s Principles for Responsible Investment, ESG integration is the “explicit and systematic inclusion of ESG factors in investment analysis and investment decisions,” alongside traditional financial considerations. ESG integration is a “value” approach, as the Principles for Responsible Investment puts it, because it’s based on a dispassionate evaluation: a cold, hard calculation of ESG risks and rewards. (The terminology for these approaches remains imprecise — many terms are used interchangeably.)
The element underlying all these strategies is research. More organizations and analytics companies, such as MSCI, Sustainalytics, and Refinitiv, are responding to the investor demand for sustainable options by providing tools and data to study sector, company, and regional exposure to ESG risks and opportunities. Most services tend to fall into two categories: indexes, and scoring of companies and funds. Besides these typically subscription-based services, the World Business Council for Sustainable Development’s Reporting Exchange has a free database of ESG ratings and rankings and also tracks sustainability reporting requirements in jurisdictions around the world. In the U.S., the Sustainability Accounting Standards Board has established 77 industry standards containing sustainability topics and associated metrics for companies to consider as they produce disclosures. As U.S. SIF notes in a road map for asset managers, because there are so many ways to add ESG factors to the investment mix, managers should prominently and comprehensively disclose their approach, including the criteria they use when adding ESG considerations and whether those criteria are applied consistently. Where investments set sustainable goals, those goals should be transparent, as should the methodologies for measuring success and the results themselves. Increasingly, skeptical investors are demanding it. In Europe, the new ESG disclosure regulations will soon explicitly require that investment managers report this information. Some of the credentialing organizations that asset managers practicing sustainable investing would want to join already do.
But even when reporting isn’t required, it’s a good idea. Broad dissemination of methods and results contributes to a communal knowledge of best practices, performance, and evolving industry standards. And as we watch the coronavirus situation play out, those standards may well change to reflect new social considerations brought out by the pandemic that firms will have to prioritize in the future. Whatever the standards, the biggest winner from transparency and disclosure is undoubtedly the firm itself. ESG strategies are what distinguish one asset manager from the competition, and ESG results forge an emotional connection with clients. Investors increasingly want to hear about ESG issues, and disclosure is their opportunity to talk about it.