ESG is a key component in global investor portfolios, with investors’ skill in assessing an investment’s viability and profitability having evolved beyond balance sheet assessments.
Market intelligence provider Broadridge Financial Solutions’ analytics platform highlights the appetite for funds that integrate ESG into their investment process, based on trends observed by a consortium of managers.
Education, regulation, adoption
As investors’ perception of ESG develops, private market managers are reacting. Historically, managers have adopted some form of ESG screening in their process – examples being due diligence on a company’s governance risk or investing in growth markets such as renewables. However, investors are now looking for sustainable returns through intentional integration rather than the greenwashing that comes from existing practices. Three key forces are driving ESG among asset owners:
- Education ESG is increasingly recognised as a factor in driving long-term returns. Greater understanding of the materiality of ESG risk leads investors to focus on a manager’s ESG policies and investment process integration. Private investors are recognised as being big agents of ESG change.
- Regulation Regulation has both encouraged and compelled change. An example of mandated change is the upcoming Sustainable Finance Disclosure Regulation, which requires entities to report on key ESG considerations. In the EU alone, a study by KPMG highlighted seven ESG-related regulations.
- Widespread adoption ESG is a persistent theme – investors see it as a material consideration. As ESG becomes mainstream, market pressure mixed with regulation will lead to wider adoption among investors.
Levels of adoption
At present, managers fall into one of four stages of ESG adoption. The minimum is an exclusions-based approach. Each stage beyond that demonstrates more purpose and intention from a manager that is actively seeking opportunities for investment above purely exclusion. This culminates in stage four: investing for impact, with an understanding that this drives long-term sustainable change, and therefore long-term alpha generation. As managers build their offering, there are critical questions they must ask to position themselves well in the hunt for capital:
- Is ESG inclusion a crucial part of the investment due diligence process?
- Have the firm shown commitment at a fund level to responsible investment, and at a firm-wide level through investment stewardship?
- How is it holding itself accountable to its commitments as responsible investors? Is it, for example, a signatory to the UN Principles for Responsible Investment?
Looking to private markets
Private markets allow investors to achieve more control over their risk/return profile while meeting their ESG goals. As liquidity fears begin to subside, investors are comfortable locking away capital in exchange for favourable private market risk-adjusted returns.
Private markets benefit from higher levels of control and influence. The influence managers can exert is far-reaching: from direct access to senior leadership in private equity arrangements, working as extended management, to structuring restrictive or subjective covenants through debt financing, with breach-of-covenant clauses.
Asset owners increasingly consider responsible investment to be at the core of capital allocation decisions. They therefore seek managers that purposefully apply an ESG lens at the portfolio and enterprise level to drive solutions. Driven by regulation and propelled by influential private market managers, ESG solutions seek to achieve stable long-term returns for global responsible investors.
Nabeel Ansari is an associate director, distribution insight, at Broadridge Financial Solutions, a US-based corporate services company