The rise of ESG: Is this the defining moment?


Sustainable investing was once seen as niche. Now it is something investors can no longer afford to ignore.

Was it a paradigm shift or window dressing? Whichever, it came as a surprise to many in the investment industry last August when America’s Business Roundtable formally stated that companies should no longer advance only the interests of shareholders, but must also invest in their employees, protect the environment and deal ethically with suppliers.

Some took this as a game-changing statement signalling the arrival of a more ethically balanced era.

Demand for services and insights into sustainable investing is surging, reflected by an ever-growing number of managed funds that explicitly invest based on environmental, social and governance (ESG) criteria.

Since the COVID 19 pandemic, ESG has become an even more important subject as it is not only a way to do well but also a way to mitigate risk in the long term.

Globally, sustainable funds based on ESG themes pulled in a record-breaking $20.6 billion of new money in 2019 – almost four times the 2018 figure of $5.5 billion, itself a record.

And Morgan Stanley’s 2019 Sustainable Signals survey found that around 85 per cent of investors are interested in sustainable investing, up from 71 per cent in 2015.

“More and more investors are starting to understand that a company cannot be understood only through its financial performance. You need to take account of its ESG information to have a much better understanding of the company’s strategy as a whole,” observes Marie-Laure Schaufelberger, head of group ESG and stewardship for the Pictet Group.

85 per cent of investors are interested in sustainable investing

In another sign of change, UK listed companies will have to tell investors all the climate risks they face under plans from the UK’s Financial Conduct Authority aimed at supporting the move to a low-carbon economy . Investors are increasingly willing to exclude some sectors and company types from their portfolios based on moral values. Asset managers should offer binding ESG commitments, rather than operating on a product-by-product basis.

Pictet has been taking account of ESG in its asset management for two decades. In 2000, it launched a strategy that invests in water, the first of its kind. It now integrates sustainability criteria across 80 per cent of its management.

In truth, ESG strategies take many forms. A portfolio manager may still invest in stocks with a poor record on ESG, but use their shareholder weight to engage with management and attempt to improve performance – particularly with small or mid-cap stocks.

In wealth management, a different dynamic operates. In the past, private investors tended to keep investing separate from philanthropic actions. The ESG philosophy instead posits a natural synergy between how we run businesses, where we invest and causes we support.

More and more investors are starting to understand that a company cannot be understood only through its financial performance

Both retail and institutional investors are conscious that major cities are choked with pollution, our oceans are under threat and rising inequality is fuelling social unrest. The next generation will take these concerns as given and pursue positive impact as a matter of course; the Sustainable Signals report found that 95 per cent of millennials were interested in sustainable investing.

“The next generation has grown up discussing environmental issues, which wasn’t the case for their parents,” says Eric Borremans, head of ES at Pictet Asset Management. “This shift is giving rise to new expectations in terms of investment offerings and solutions.”

Many investors are willing to give up some of their returns for known environmental and social benefits. But they may not have to. Morningstar recently found that 73 per cent of its ESG indexes have outperformed their non-ESG equivalents since their inception.

73 per cent of its ESG indexes have outperformed their non-ESG equivalents since their inception
(Morningstar)

An ethically centred approach to customers, employees and the world at large is increasingly seen as an indicator that a company is a good long-term investment. Since the COVID-19 pandemic, ESG has become an even more important, highlighting the need not only to do well by society, but also a way to mitigate risk in the long term.

ESG stocks are tied to powerful trends such as sustainability, demographic development or technology – and may grow faster than the wider economy. In turn, investors will be more likely to stick with them through difficult markets, benefiting from the rebound and avoiding locking in losses.

Asset managers employ various means to track the impact of their ESG strategies. Although company reporting standards need improvement, technology helps in capturing relevant data and satellites can track some environmental degradation – independently of the company or country.

“The next generation has grown up discussing environmental issues, which wasn’t the case for their parents”

Although passive investment is capturing an increasing share of the stock market, robotically tracking an index may inadvertently finance some questionable companies in ESG terms.

Active managers, by contrast, can take a stand. Swiss Sustainable Finance is a global industry group committed to advancing responsible investment. It recently launched a campaign calling on index providers such as MSCI and S&P Dow Jones to exclude the makers of controversial weapons from their indexes.

Swiss Sustainable Finance represents US$6.8 trillion in investor funds. Among its 140 members is Pictet, which has enforced a strict exclusion policy on companies involved in controversial weapons for all its actively managed strategies.

Like asset management itself, ESG involves long-term thinking and making changes based on sensible conviction; one reason why the two go hand in hand so well.

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