In the last few years, the investment community has seen a remarkable rise in client interest in responsible, sustainable or ethical investment strategies. These strategies typically include consideration of environmental, social and governance (ESG) issues as part of the investment process. According to the Global Sustainable Investment Alliance, over $30 trillion of assets was allocated to sustainable investments at the start of 2018 and the ESG market share continues to grow.
This interest in ESG was genuinely shown at the CFA “ESG investing” conference on Tuesday. Over 500 attendees representing some of the largest asset owners, buy-side and sell-side institutions filled a large conference venue in Bishopsgate, just around the corner from Liverpool Street station in London. This was a significant increase from 100 who attended the inaugural CFA ESG conference last year.
This year the audience was treated to a star-studded line up of speakers which included leading ESG practitioners, academics, CEO of the PRI Fiona Reynolds and Governor Mark Carney.
Here are my top three themes which I took away from this conference:
ESG risk pricing and the hunt for alpha
Fiona Reynolds highlighted that markets have not yet adequately priced ESG risks. Partly this is because ESG data on issuers is unstructured, often qualitative and can be hard to benchmark against traditional economic indicators e.g. current ratio or EBITDA for corporates or national income, inflation or GDP for sovereigns. In addition, investors have not yet priced in the cost of compliance with new regulatory requirements around ESG disclosure and transparency, such as the EU Shareholder Rights Directive II or the DWP rules for UK schemes. This includes both operational costs of data and reporting and transaction costs incurred if the portfolio has to be realigned with the scheme’s statement of investment principles which must now include consideration of ESG factors.
One of the most interesting questions raised was, can ESG be the source of alpha in its own right? At the moment there is not a definitive case for that, but studies have consistently shown that ESG engagement can translate into improved financial returns. In addition, mispricing of risk can create interesting opportunities for alternative or contrarian investors who like to hunt for alpha in areas where there is disagreement between market participants and where low correlation equals high dispersion – which can translate into a source of alpha. This is a powerful counterargument for those who are concerned that getting on board with ESG will compromise fund performance.
The role of asset owners
Asset owners are absolutely key in driving forward growth in responsible investing. A lot of interest in ESG comes from stewards of large asset pools with long-dated liabilities, for example CalPERS manages liabilities of over 100 years duration. A lot of growth in ESG investing is coming from consolidated pension plans in the Netherlands, Nordics and Australia – which are some of the key markets for AMX as well. In the UK, the market is more fragmented with many smaller dispersed pension schemes. However, with the rising consolidation trend among UK DB schemes and increasing regulatory pressures it can be expected that the level of interest in ESG among UK pension schemes will continue to increase.
Asset owners are shouldering much of the regulatory burden around ESG risk management and reporting. So it is not surprising that when it comes to appointing managers, the manager’s approach to ESG and the level of ESG integration into the investment process is closely scrutinised. The bar is currently lower for value and quant managers for whom ESG integration is less straightforward, whereas for equity managers, there is an expectation that they should be already integrating ESG as part of their investment process.
The role of data
Just as the asset owners are key to driving the ESG investing forward, data will be key in informing their investment decisions. The problem is that the ESG field is still relatively new and oftentimes there is only a very limited time series of ESG data is available e.g. a few years as opposed to decades of inflation or other economic data. This is not always enough for a meaningful analysis and it makes modelling for the long term i.e. 20-30 year horizons challenging. That said, ESG factor attribution can be done on any fund regardless of the underlying strategy in order to help investors/asset owners to understand risks.
I would like to close with a quote from Mark Carney: “over time it will be less and less sustainable for managers not to have a view on ESG.” It is clear that the industry has heard the message loud and clear. In addition, regulation, carbon pricing and social awareness will be sure to continue to keep ESG in the headlines for the years to come.
Photo credit: Paul Sheehan