Fiona Reynolds, CEO of the UN’s Principles of Responsible Investment (PRI), has recently heard ‘very large fund managers’ call ESG the ‘fad of the moment’. Given the level of airtime currently being enjoyed by ESG backers you’d be forgiven for thinking it has become a success overnight, but in fact its rise to prominence has been many years in the making, Reynolds says. ‘Responsible investment really has been growing over the past decade, and every year there is more momentum. But I would definitely say in the past two to three years there has been even greater momentum,’ Reynolds says.

This is hard to argue with, particularly given recent flows into ESG approaches in Europe, the spiritual home of responsible investing. Net flows into European sustainable investment funds in the first half of 2018 were €32.1 billion, an 11.5% increase on the previous six months and only the second time it has exceeded €30 billion in the past five years. To put this into context, since its founding in 2006, the PRI has attracted support from more than 1,800 signatories representing more than $68 trillion in assets under management (AUM), or €58 trillion – roughly half of the world’s entire AUM.

There is also the proliferation of new ESG funds, as well as the trend for repurposing underperforming funds to give them an ESG focus. Although this could be viewed as opportunism or jumping on the bandwagon given the inherent complexity of establishing a quality ESG offering, it does highlight the perceived dichotomy between ‘value’ and ‘values’.

Doing good or doing well?

‘Should investors seek to do good or should they aim to make money?’ asks Lewis Grant, a senior portfolio manager in Hermes’ global equities team and manager of the Hermes Global Equities ESG fund. ‘There will always be investors more concerned about the wider impact of their investment than purely returns, and the rise of the more socially minded millennials and the increasing proportion of wealth controlled by women may facilitate an increase in this area; however, most investors, asset-owners and fiduciaries assess success in monetary terms. In some jurisdictions fiduciary duties have even been viewed as a barrier to considerations beyond maximising investment returns.’

Yet this is changing. France, via Article 173 of the law on energy transition for green growth, has become the first country to introduce mandatory climate-change-related reporting for institutional investors. In the UK, the Department for Work and Pensions recently stated that trustees must consider ‘financially material’ ESG risks and opportunities.

Responsible investment really has been growing over the past decade, and every year there is more momentum

Fiona Reynolds, UN PRI

Such progress is notable given that institutional investors provide the largest flows to ESG funds. According to the recent Performing for the Future report by State Street Global Advisors, 80% of institutions have an ESG component in their investment strategies. Some 68% say that this has significantly improved returns, while 69% believe that pursuing an ESG strategy has helped manage volatility, and three-quarters have the same performance expectations for ESG as any other investment.

This activity should only grow considering that, according to the same report, only 17% of institutions have more than 50% of their assets with exposures to ESG, a third have only 25-50% exposure and 44% have less than 25% exposure.

Yet there remains a degree of caution around sustainable investing among institutional investors. ‘I think in the institutional market there‘s a lingering perception that if you make any serious attempt to integrate ESG into the investment process you then get a suboptimal performance. ‘It’s a myth, it’s not true, but it still sits in the minds of older generations of fiduciaries, as they think of ethical investment and heavily screened ethical funds, which was where we started,’ says Will Oulton, global head of responsible investing at First State Investments.

A wider world

Today the ESG landscape is diversifying. On the demand side, millennials are driving investment product innovation. According to EY research, millennials are twice as likely to invest in companies or funds that target specific social or environmental issues than previous generations, and twice as likely to exit objectionable funds or stocks. This generation is poised to receive upwards of $30 trillion in inheritable wealth.

Additionally, against a backdrop of the Paris Agreement and the UN’s Sustainable Development Goals, concerted efforts are being made by regulators globally to clarify, control and funnel sustainable finance.

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