ESG investments are to grow across all asset classes, according to a survey of 300 investment fund companies sponsored by the Index Industry Association (IIA).
ESG remains one of the top themes among asset managers, and ESG index providers are highly trusted by asset managers to drive progress in ESG investing.
Fixed income will likely outpace equities as an ESG asset class based on its rate of growth in the last year, and projections of growth in related issuance.
Evolving standards and regulations could help fill the gap in transparency and public disclosure by companies by improving ESG corporate data and ratings.
The rise of ESG likely to continue into the next decade
Despite recent global economic uncertainty and geopolitical turbulence, asset managers not only reported strong growth in ESG investment over the past year across asset classes but believe it will continue well into the future.
Even though ESG has been experiencing some backlash driven by concern about standardisation, data transparency, rival methodologies etc, the growing commitments to net zero and a low carbon will continue to be the primary driver of investment.
In the past year, a large majority (85%) of survey respondents said that ESG has become more of a priority in their company’s overall investment offering or strategy.
While most asset managers surveyed incorporate all three ESG elements into their portfolios, this year’s survey shows that the ‘Environmental’ portion receives priority. Four-fifths (80%) of respondents overall agreed that “environmental criteria almost always tend to be prioritized over Social and Governance criteria.”
Furthermore, a focus on climate change or carbon footprint was the sole focus of many (74%) of portfolios. Index benchmarks provided by IIA members were identified as an important link in the ESG investment value chain.
Fixed income issuance tracks green and sustainable issuance
A substantial rise in green and sustainable bond issuance (GSSS) supports the rise in popularity of fixed income ESG as an asset class among portfolio managers. Corporates, state and local governments, and even sovereign funds are eyeing increased GSSS issuance to fund their decarbonisation plans.
Although market and economic headwinds have subdued first half volumes, market estimates see a full-year increase to an estimated $1 trillion of issuance in 2022.
GSSS issuance is increasingly being viewed as preferable to regular bonds by many corporates, such as Iberdrola (MC:IBE), which is planning to generate most of its finance from green and sustainable vehicles. Green and sustainable bond issuance from good quality issuers may also enhance data transparency from corporates, thereby improving ratings, which is identified by a weakness in the ESG value chain.
Evolving standards and regulations may help with data, ratings lag
A much higher proportion of survey respondents (93% compared to 66%) believed ESG tools, metrics and services were either highly or fairly effective than they did in 2021. Yet complaints were still made about rating and providers – the apparent contradiction raises the possibility of more funds (and hence portfolios) being mislabelled or worse, accused of greenwash.
ESG corporate data and ratings are where there is significant room for improvement, with 31% of respondents citing a lack of transparency and the need for greater public disclosure of companies’ ESG activities. They also highlighted a lack of data standardisation across markets and sectors (29%), a lack of agreed ratings and methods among providers (28%), and a lack of quantitative data (23%).
Despite the geopolitical and economic turbulence of recent times, a large majority of respondents indicated that ESG measures are keeping up very (30%) or fairly (59%) well with world events over the past 12 months. However, respondents did see room for improvement, particularly around the need for better integration of geopolitical risk factors.
ESG growth requires standards and consistency, as well as regulatory weight
Improved standards and rules around disclosure are needed to reduce anomalies in data interpretation and the subsequent ratings they produce. There is ongoing debate about whether and how environmental, social and governance factors are used to evaluate companies is warranted, rather than a combined ESG rating. Of course, the challenge with that is that by separating each area the ability to address interrelated impacts and complexity is lost.
The separation of E, S and G factors may well be needed to address the concerns around rating anomalies and lack of transparency of data. An important outcome could be that investors will be able to focus equally on the social and governance factors, rather than just environmental issues, in their investment decision making. Of course, for that to be the case, mandatory disclosure regulations would need to evolve.
The survey respondents were chief investment officers, chief financial officers and portfolio managers across four major financial markets of the Unites States, United Kingdom, France and Germany.