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Special Report: ESG takes root

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One in every four professionally managed dollars is now invested sustainably according to some definition, with a total of $22.9trn run in this way overall, according to the Global Sustainable Investment Alliance.

From a broad perspective, ESG investing approaches can be said to encompass climate change mitigation strategies such as low-carbon indices, as well as green infrastructure investment, stewardship, engagement, and more familiar exclusionary investment policies. 

For years, SRI, sustainable, responsible or ESG investing, as it has variously been referred to, languished at the periphery of finance. There was, and still is, widespread suspicion that it reduces returns. Yet, according to Morgan Stanley, in a 2018 report, the concept of “sustainable investing has enabled investors to think more systematically about risks of unexpected, costly issues arising from ESG factors that can hurt long-run returns”.

In its June 2013 World Energy Outlook report, the International Energy Agency (IEA) warned that the world was off track in meeting the internationally accepted 2°C global warming target that has since been embedded in the 2015 Paris climate agreement. The IEA drew attention to considerable economic risks that arise from policy measures aimed to stem the risk of rising global temperatures. 

The term ‘stranded assets’ – to describe the risk of unburnable carbon – was coined to encapsulate the risk to investors that this entails. Exposure to the oil, gas and other carbon intensive sectors was recognised as a key risk to institutional portfolios and to pension beneficiaries. 

Mark Carney, Bank of England governor, weighed into the debate in 2014 to support the contention that investors should measure, manage and reduce the carbon exposure in their portfolios. 

The Taskforce for Climate Related Financial Disclosures, was set up under the auspices of the Financial Stability Board in 2015, of which Carney was then chair. Its aim is to develop voluntary climate related disclosures to guide the allocation of capital. 

The financial services sector moved quickly in response to the decarbonisation agenda, and a variety of low-carbon indices have been launched since 2014 by leading index providers in partnership with asset managers like Amundi and Goldman Sachs Asset Management, and investors including AP4 and the New York State Common Retirement Fund. 

ESG integration is a hot topic for asset management CEOs and CIOs currently – not just in Europe and the US, but also in countries like China, where leading managers have become members of the PRI, one of the leading global ESG groups. There are some sincere and highly robust models for integration of ESG in the portfolio management and risk process, even if progress is patchy, internal buy-in limited or efforts skin-deep in some cases.

In short, many institutional investors, portfolio managers and analysts, in both bonds and equities, now regard ESG risks as mainstream. And in a world with ever increasing potential to process and interpret data, the opportunities in measuring and evaluating ESG risk are vast. 

But in order to manage risk it first needs to be measured. This is why the work of TCFD but also other groups like CDP is so important in systematising corporate data disclosure – and spreading the message that it matters, not just for carbon but also for other areas of natural resource consumption, like water.

Morgan Stanley’s estimate of over $20bn sustainably invested assets may be impressive but asset numbers and labelling are not the main point. At the root of ESG adoption is the firm belief of many fiduciaries that promoting better disclosure of non-financial risks by corporates underlies their duty towards beneficiaries as long-term investors, whether this be through dialogue or through the withholding or withdrawal of capital. 

Liam Kennedy, Editor, IPE

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