ESG Makeover for Investment Industry


The COVID-19 pandemic has heightened our expectations of environment, social and governance (ESG) investing across the globe. Although it has been a mainstream topic for asset managers in Europe for some time, a growing concern for ESG-related issues is spreading further worldwide.

There is increasing demand for disclosure, data and information which is compelling asset managers to integrate ESG analysis more explicitly into their due diligence and portfolio construction. At the same time, we anticipate that the pandemic will drive an investor flight to quality across the globe – companies with strong balance sheets and good governance. In that respect, it could also act as a catalyst for ESG investing.

As a rule, quality companies are better positioned to sustain earnings growth in the face of macroeconomic headwinds, including ones caused by a global health pandemic. Owning quality remains the best way for equity investors to mitigate risk. There’s plenty of research to suggest that companies with high-quality ESG standards outperform over the long term.

Whether driven by societal expectations or recognition that ESG analysis can add meaningfully to returns, increasing ESG adoption would enhance engagement between companies and investors. That would be a major plus for the sustainability of both investment portfolios and the planet.

With climate change forecast to heighten the intensity of weather events further in future, it will become crucial for corporates, institutional investors and asset management companies to answer two key questions: 1) how does my business/investment impact the environment; and 2) how the environment impacts my business/investment. This will likely accelerate investment into renewable energy and sharpen investors’ focus on the resilience of infrastructure – roads, railways, ports and airports – prompting a shift in the composition of investment portfolios.

While interest in ESG investing has developed in recent years, asset managers and institutional investors adopt different approaches in obtaining their ESG data; from contracting third-party providers to embedding ESG capabilities into their own teams. Increasingly, asset managers are opting for the latter, recognising the value it can bring in safeguarding the sustained success of portfolio companies.

In terms of the data, we expect to see a meaningful improvement in the quality and consistency of this, as stock exchanges and regulators strengthen disclosure requirements. That will compel corporates to improve the breadth and granularity of information they provide, shifting from quantitative to qualitative data. Investors will want to understand the sustainability of companies’ strategies and the improvements these firms could make to enhance their value.

Yet, even now some companies regard ESG as publicity activity than a business imperative. That will all change as they come to view factors such as corporate disclosure and resilience to climate change as essential to the sustainability of their business. Management teams will need to know, and be able to demonstrate to their boards of directors and investors, how their business models will remain valid in 10 years’ time. To do that they will need to identify and guard against ESG issues that could cause disruption, from data breaches to supply-chain risks to discontent among staff that prompts turnover of key personnel and loss of knowhow. The game-changer will be seeing ESG as a means not only to manage risk, but also to drive returns. Firms able to showcase how they safeguard customer data, prioritise environmental sustainability, foster a good staff culture and maintain standards among their supply chain will resonate with consumers. That will drive profitability, and consequently investor interest.

Finally, we expect institutions will start defining ESG parameters that fund houses must adhere to in managing portfolios over the next few years. While they will feature traditional performance requirements, mandates may also require investment partners to work within a carbon budget; or manage a portfolio of companies that achieve a minimum ESG score; or build a portfolio with quantified environmental or societal impacts. While this is underway in parts of Europe, growing concern about ESG issues among governments and societies more broadly will dictate that it accelerates across Asia, the US, and the rest of the world over the coming years.

*Written By David Smith, Head of Corporate Governance, Asia Pacific, Aberdeen Standard Investments


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