Pandemic, war and climate change sharpen focus on ESG

by Jessica Ground, Global Head of ESG, Capital Group

While COVID-19 helped accelerate the ESG agenda, the tragic invasion of Ukraine is likely to further speed up its evolution.

The pandemic shone a spotlight on the “S” — or social issues — of ESG. The conflict in Ukraine has brought the “G” (the governance component) to investors’ attention. At the same time, a growing understanding of the implications and importance of climate change has meant that “E” (the environmental piece) continues to dominate investors’ ESG focus.

These insights and many more surfaced in Capital Group’s annual ESG global study published in May 2022. Collecting views from more than 1,100 institutional and wholesale investment professionals across Europe, North America and Asia-Pacific, the study showed ESG trends continue to gain traction.

ESG momentum builds

Momentum behind ESG and sustainability continues to build, fueled by investor demand and a desire to make an impact. Compared with the previous year, a higher proportion of global investors describe their ESG stance as one of conviction, acceptance or compliance. This global cohort of ESG adopters rose to almost 90%, up from 84% in 2021. Over the same period, the number who are either on the sidelines or non-adopters has fallen to 11%, down from 16% the previous year.

ESG adoption by global investors continues to grow

“Conviction” represented 26% in 2022 versus 28% in 2021. “Acceptance” represented 34% in 2022 versus 32% in 2021. “Compliance” represented 29% in 2022 versus 24% in 2021. “On the sidelines” represented 10% in 2022 versus 13% in 2021. ”Non-Adoption” represented 1% in 2022 versus 3% in 2021. Survey legends as follows: Conviction: ESG investing is central to our investment approach. Acceptance: We apply ESG investing in our investment approach. Compliance: We consider ESG issues in our investment approach. On the sidelines: We are yet to be convinced about ESG.

Source: Capital Group, ESG Global Study 2022.

Conviction in ESG is further underscored in the finding that just 13% of global investors agree ESG is a passing fad and will go out of fashion. This demonstrates how most investors view ESG as a permanent and pre-eminent part of the investment landscape.

ESG poised to become a permanent part of the investment landscape

 Capital Group’s ESG Global Study 2022 found that 13% of investors agreed with the statement: “ESG is a passing fad that will eventually go out of fashion.” Sixty-one percent of investors disagreed with the statement, while 26% of investors neither agreed nor disagreed with the statement.

Source: Capital Group, ESG Global Study 2022.

The “E” of ESG continues to dominate, but greater recognition of “S”

The structural and societal pressures arising from climate change have been key in driving environmental issues — the “E” in ESG — to the top of investors’ sustainability concerns. The study showed that the environment continued to dominate allocation decisions, with investors increasing their focus on “E,” which rose from the year before (47% vs. 44%).

The “E” in ESG still dominates

Respondents to Capital Group’s ESG Global Study 2022 were asked: “What percentage of your ESG focus is, or would be, allocated to these three segments (ES&G)?” The answers in 2022 were 47% “E,” 25% “S” and 27% “G.” In 2021, the answers were 44% “E,” 25% “S” and 31% “G.”

Source: Capital Group, ESG Global Study 2022.

Although investors indicated an even greater focus on environmental issues in 2022, there are signs that this may change in the future as people recognize an imbalance. When asked whether social issues are being overlooked by this environmental focus, 41% of investors agreed.

Qualitative research we carried out as part of the study suggests some reasons behind these views. It is possible that the impact of the COVID-19 pandemic raised greater awareness on the importance of safe working conditions, access to health care and education.

The “S” in ESG is rising in prominence

Respondents to Capital Group’s ESG Global Study 2022 were asked: “To what extent do you agree or disagree that social issues are being overlooked in the debate on climate change?” Forty-one percent agreed that social issues are being overlooked, while 21% disagreed. Thirty-eight percent neither agreed nor disagreed.

Source: Capital Group, ESG Global Study 2022.

As strict lockdowns were imposed across the world, companies operating in the retail and health care sectors came under particular pressure to ensure the safety and well-being of their workers. Many responded by providing protective equipment or extending paid sick leave to temporary staff and contractors. Other companies provided their goods and services free of charge — such as internet access, video conferences and remote learning to schools and universities — as a way of supporting their broader communities.

With an increased understanding that social issues can have material and far-reaching consequences for companies and the communities they serve, the impact of the pandemic may have prompted investors to look across a wider range of ESG issues.

“G” increases its profile

Russia’s invasion of Ukraine also brought several ESG issues into the spotlight, with concerns around governance flagged by respondents in the survey.

The global response to Russian aggression was not just political, as the corporate sector was quick to take a stance. Many companies made statements regarding their business exposure to Russia.

At Capital Group, we followed company actions closely. While much of the media focus was on actions announced publicly, we paid particular attention to companies that had not made public statements. Digging behind the public pronouncements helped us to gain a better understanding of the impacts and how companies’ license to operate may be affected.

Sentiments on governance concerns were echoed by a number of investors surveyed.

“I think the crisis should, and probably will, bring governance into sharper focus,” says the CIO of an independent advisory firm. “But that should have always been the case — it’s sad that we need a tragedy and war to highlight the importance of the ‘G’.”

A portfolio manager at a wealth management firm agreed: “I think the crisis has strengthened the ESG argument because it really is making people focus on what’s important — and that’s social governance, which is right up there in my view.”

The impacts of major world events have always been felt in investment markets. Building an understanding of the first-, second- and third-order effects of events and how these might impact investment decisions is not new. Viewing the consequences of these events through an ESG lens can provide a richer perspective and help frame events for investors.

However, there are still challenges to overcome, which the survey also highlighted.

Access to reliable and consistent ESG data remains a key challenge

A theme that came through loud and clear in last year’s study, and was reinforced in this year’s results, is the difficulties experienced in accessing and interpreting ESG data. Specific issues raised by respondents included access to ESG data, consistency between ESG data providers and transparency of benchmark and index data.

Difficulties with the robustness of data and inconsistent scores are hampering the ability of investors to incorporate ESG considerations into their investment process.

ESG ratings and accessing data remain the largest challenges

Respondents to Capital Group’s ESG Global Study 2022 were asked: “What is your No. 1 challenge when implementing ESG investments?” Reponses were as follows: “ESG ratings’ consistency” at 25%; “Accessing ESG data” at 24%; “Measuring ESG performance” at 21%; “Management approach consistency” at 13%; “Transparency” at 9%; and “Engagement” at 7%. One percent answered ”Don’t know.”

Source: Capital Group, ESG Global Study 2022.

The No. 1 challenge global investors cited in implementing ESG investments is a lack of consistency between different ESG rating providers (25%). This was closely followed by difficulties accessing ESG information and data.

Inconsistent and inaccurate ESG scores result from a multitude of factors. These include backward-looking data that fails to adequately assess the future value of companies transitioning to address sustainability issues. These companies could play an important role in driving change and may become tomorrow’s ESG leaders. The subjective nature of scoring systems also means there are varying views on the relative importance and material impact of different ESG factors in different sectors and countries.

Consistency in regulation was also raised as a significant roadblock. Investors are looking to regulators to provide common standards and definitions. When asked what the ESG regulatory framework should prioritize in their respective countries, the highest proportion of respondents cite the need to harmonize global standards, taxonomies and metrics (45%). This indicates investors are struggling to untangle an increasingly complex and disjointed web of global regulations issued by different entities.

Overcoming data challenges will help ESG to broaden its reach. Results from our global study show that momentum behind ESG and sustainability continues to build. Despite challenges around data, it appears that investors’ awareness of ESG topics is not just increasing, it is also broadening to cover a wider range of social and governance issues.

For a more detailed look at the latest findings, check out the full survey.

Jessica Ground is global head of ESG at Capital Group. She has 25 years of industry experience (as of 12/31/2021). She holds a bachelor's degree in history from Bristol University and is a member of the CFA Institute.

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