Pensions Expert 20th Anniversary: Environmental, social and governance investing is much more than a fad, says the Pensions and Lifetime Savings Association’s Luke Hildyard.
And whether or not the term ‘ESG’ survives another two decades in an industry where terms such as 'socially responsible investment', ‘impact investing’ and ‘stewardship’ sashay in and out of fashion like models on a Milanese catwalk remains to be seen. However, environmental, social and governance considerations are only likely to become more integral to investment practices.
We might reasonably consider the industry to be in the early stages of an ESG supertrend
Indeed, a confluence of factors has brought us to the point at which we might reasonably consider the industry to be in the early stages of an ESG or responsible investment supertrend.
Figures from Eurosif suggest that sustainability-themed investments in Europe grew by 146 per cent between 2013 and 2015, with continued growth likely since then. More than three-quarters of pension funds responding to the Pensions and Lifetime Savings Association’s stewardship survey said they believe that ESG factors are material to investment returns. Seventy-one per cent said stewardship practices are a factor in their asset manager selection.
Market shows keen interest
When we invited PLSA members to submit views for potential topics to feature at our annual investment conference in Edinburgh next March, the number of suggestions for ESG-related topics was more than double that for any other theme. The market response to this thriving interest can be seen throughout the investment chain.
Asset managers are bolstering ESG and engagement capacity and integrating more closely into investment processes. Indexes constructed using ESG-related criteria are proliferating and becoming increasingly sophisticated. Consultants are fast developing a capacity for ESG-related advice.
But to understand whether these are lasting changes to the investment industry or passing fads, it is useful to examine the developments over the past 20 years that have driven them.
Looking firstly at the ‘E’ of ESG, though an established scientific concept in 1997, climate change was still of relatively little public or political interest. Since then, there have been countless campaigns, international treaties, commitments by national governments, broadcast documentaries and scientific studies – not to mention extreme weather incidents – raising the profile of the issue.
The physical impacts of climate change on industries from food production to insurance, and the impact on sectors likely to be highly regulated as part of efforts to mitigate dangerous temperature increases, such as oil and gas or mining, are far more clearly understood.
Living wage and tax campaigns using shareholder activism to achieve social outcomes have also become commonplace in recent years. In the UK, innovations such as the Stewardship Code and the ongoing industrial strategy plans and patient capital review are raising expectations of the investment industry’s long-term stewardship of its investments.
Similar projects are taking shape at European level, through the work of the High Level Expert Group on Sustainable Finance, for example.
Free hedge rather than performance detractor
Naturally, academic and research interest in the investment case for ESG investing and the growth in the ESG market have been mutually reinforcing. A number of studies have demonstrated a positive relationship between ESG scores and investment performance. There are some researchers that dispute this.
But as Doug Morrow from research and ratings company Sustainalytics writes, there is at least “growing consensus that ESG integration is not value-destroying and may offer a free hedge against intensifying ESG risks” such as climate change, poor corporate governance or regulatory and reputational problems.
To understand the importance of ESG, we need to ask whether these trends are likely to endure. The need to address climate change is becoming even more urgent, with profound implications for investors. Global governments are also committed to the achievement of the UN Sustainable Development Goals, which will create further regulatory and societal pressure on the investment industry. The academic case for ESG is certain to be bolstered.
ESG seems guaranteed to be an even bigger part of the next 20 years than it has been for the past 20, with perhaps only the ever-changing terminology subject to an uncertain future. Maybe by the year 2037, ESG investment will be so mainstream, it will just be called investment.
Luke Hildyard is policy lead for stewardship and corporate governance at the Pensions and Lifetime Savings Association
