Challenges and opportunities within the ESG space

by Nathan Miller, Equity Portfolio Manager, Invesco Canada

As consumers, we’re more aware of the environmental and social impact of our consumption than ever before – and today, awareness has an impact on many people’s investment choices.

The growth and attention around ESG (Environmental, Social and Governance) investing within investment communities has progressed at a tremendous pace. In the U.S., ESG assets have grown 38% between 2016 and 2018,¹ and 2019 appears to be no different. Yet as with many things that grow quickly, there can be growing pains, as well.

Today’s ESG investors face a few recurring challenges:

“Green-washing”

Some critics have argued that the significant growth in ESG assets is due to green-washing (i.e., when an asset manager uses some level of ESG data to aggregate an ESG score for their strategy or fund, with little effort to truly understand or integrate ESG into their investment framework).

Fortunately, I’d argue this practice is becoming less common as investors grow more informed about how asset managers are implementing ESG into their investment process. For example, due diligence questionnaires no longer have a mere ESG checkbox, but instead include thoughtful questions to understand the ESG process and stakeholders, third-party partnerships and how additional data is leveraged.

Inconsistent ESG disclosures

Another challenge involves the inconsistent ways companies disclose information about their environmental, social and corporate governance practices, which are not always comparable across corporations.

On the positive side, we’re thrilled that companies are reacting with transparency to investor’s requests for ESG-related information – information that’s fundamental to assessing some of the risks that they face. However, it can be difficult to determine how one company’s ESG information compares with that of another. One of the most common solutions is to use a dedicated research firm or team to aggregate the data into something comparable and quantifiable, often with a score and key findings about a corporation’s ESG practices.

Education gap

Finally, asset managers continue to face an education gap. With so many different approaches falling under the umbrella of socially responsible investing, it’s imperative that asset managers’ intentions align with investors’ expectations. We feel that this presents a unique opportunity for asset managers, financial advisors and investors alike to build a meaningful investment dialogue around the purpose of ESG investing.

What are some of the opportunities that exist in the ESG space?

There are two sides to the opportunities that exist within the ESG context: the asset managers/investors; and the companies in which they invest.

In April 2006 the United Nations launched the Principles for Responsible Investment (UNPRI) based on the idea that ESG issues should be considered part of the investment process, as they can influence investment returns. There are now more than 7,000 signatories to the UNPRI, according to the UN’s dedicated website, unpri.org. Merely becoming a signatory doesn’t qualify someone as an ESG manager, but it’s the first step in beginning to align the investment framework with some commonly agreed upon principles.

There are opportunities on the corporate side as well. As mentioned above, we believe the primary opportunity comes through developing clarity around what is (or isn’t) being reported. Much like the Generally Accepted Accounting Principles (GAAP) pioneered by the Financial Accounting Standards Board, responsible investing has seen the emergence of the Sustainable Accounting Standards Board, which was established to provide a commonly agreed upon set of reporting standards that are applicable within a company’s sector/industry.

Where is the interest in ESG coming from?

Millennials are often cited as the generation with the greatest desire to align their values with their investments. According to recent research from Morgan Stanley, that’s true, but interest outside of that generation is actually growing at a slightly faster rate.²

A recent survey by Morningstar showed significant interest from Generation X in ESG investing. With most Baby Boomers firmly into their retirement years, their interest has moved toward preserving their savings. However, as Generation X lands squarely in “peak savings” mode, their conversations around ESG investing are likely to increase.

Final thoughts

Amid the growth seen around ESG, one thing remains clear: Investors want to understand a company’s long-term value creation plan, initiatives, best practices and any inherent risks (both financial and non-financial) via more standardized information around ESG. Management teams at publicly traded companies appear to have gotten the message that investors want more ESG-related information – but it is still up to the investors to determine how they use that information.

We expect the growth in assets and interest around ESG investing to continue in the years to come. With that growth will come new challenges and opportunities, but ones that we will lean into rather than shying away.

This post was first published at the official blog of Invesco Canada.