How ESG Is the Growth Opportunity of the Century
ESG investing is no longer just a niche investment strategy. According to PwC Luxembourg’s first European Sustainable Finance Series report, ESG investing is the growth opportunity of the century. In this article we have broken down the report, sharing our reactions and predictions for what this means for you as an advisor in 2021.
European Sustainable Finance Series Report: The Big Takeaways
The report predicts that the boundary between traditional and sustainable investments will all but disappear by 2022. Investors today are increasingly prioritizing non-financial impacts in tandem with their financial returns.
Instead of these two things remaining mutually exclusive, the report predicts a convergence between financial and sustainable performance and ESG and non-ESG products. As millennials enter their peak earning years and continue to shape investor preferences, the prediction is that this cannot be considered a trend, but rather a shift in the entire investment landscape.
At OpenInvest, we’ve seen this shift towards values-based investing. We believe that ESG will mainstream as a long-awaited feature, rather than a niche or specialty product. According to the report, this shift in the investment landscape towards ESG investing is a result of four main factors:
1. Complete regulatory overhaul
As the report indicates, there is a shift in EU regulation for ESG moving from voluntary regulations to binding legislation. As regulatory momentum continues and EU regulators lead this effort, corporations across the globe are expected to experience more and more financial pressure to comply with or implement sustainable initiatives.
We’ve also talked about how a new Biden administration in the U.S. could also add to this continued regulatory pressure in our blog post “The Transition to a New Administration: What This Means for ESG Investing”, by requiring companies to disclose and increase transparency around ESG-related risks that affect their bottom line. This continued pressure will drive us further towards a more sustainable model of investing.
2. ESG’s outperformance
The myth that investors must sacrifice high returns for investments that match up with their values has been squashed time and time again, even throughout the market volatility of 2020. Exhibit 7 below from PwC’s report gives evidence for how the pandemic’s impact was not felt as strongly in the ESG space compared to the overall market.
ESG performance in 2020 offers a helpful window into the future of mitigating financial risk. Our blog posts on “What COVID-19 Teaches Us About ESG Investing” and “Investors Look to ESG Investing During Market Volatility” give additional detail on why this myth holds little ground as we navigate the future financial landscape.
3. Increasing investor demand
This new generation of investors cares about more than just the financial gain of their investment portfolio. They want to understand the societal impact of their investments, and they need their advisors to make it easy for them to do this. As investor pressure increases, this will only continue to translate to the investment portfolio, as shown in Exhibit 8 for European ESG vs. non-ESG funds.
4. Fundamental societal shifts magnified by current environmental, social, and health crises
2020 not only brought us COVID-19 and the harsh reality of ESG risk unpreparedness, but increasing unrest due to racial and gender inequality, a stronger focus on wealth disparity, and escalating concerns over the climate crisis. All of this has led to increased pressure on ESG standards for everyone from advisors to government officials to companies themselves.
According to WEF’s Global Risk Landscape (Exhibit 10), ESG risks are ranked higher in terms of impact and likelihood compared to politically prioritized threats such as terrorism or financial failure. This demonstrates the importance of prioritizing ESG risks in an investment portfolio to avoid any future financial repercussions.
What this means for advisors
At OpenInvest we agree that the investment world is changing and the question for advisors becomes about how to adapt to this changing landscape. We are offering our perspective in conjunction with PwC’s report on how you, as an advisor, can thrive in this new investment landscape:
Follow investor interest
While the report indicates that there is an increase in investor demand, we haven’t seen a major shift yet in investor assets to reflect this demand. While 85% of individual investors and 96% of millennials are interested in sustainable investing, for now, this is still just “interest” and isn’t necessarily translating to portfolio action.
We believe a major reason for the lack of translation from interest to action is the iron law of wealth management: clients very rarely switch products or providers. Right now, ESG investing is considered by many wealth managers a specialty or niche product and is not ingrained in current offerings.
Most investors don’t want to mess with their finances or take the time needed to investigate and add on additional functionality for a further cost. Simply put, they don’t want to spend more money and more time “figuring out” ESG. After all, that’s what they’re paying you for: to figure things out for them.
However, although clients aren’t shifting all their assets right this moment, they are increasingly conscious and interested, as the data shows. Millennials especially are bringing ESG investing to the forefront as they change the game on what “investing” means. For millennials, it’s no longer just about financial gain but about changing the world to match their values one investment at a time.
According to research, “75% of Millennials believe that their investments can influence climate change” and “84% believe that their investments have the power to help lift people out of poverty.” As an advisor, this is an opportunity to ride the wave of the future of ESG investing and provide additional value to your clients. We call this the “Client-First ESG Revolution”. This is especially true as your retiring Baby Boomer clients are outweighed by millennials who have very different ideas on what smart investing looks like.
If you make ESG investing easy for them to implement and understand, without having to re-examine their asset allocation, tax reporting, personal loans, and IRA, then it becomes a no-brainer for your investors and a win-win for your business. They are looking to you as their advisor for guidance on this and to make it easy for them to understand and build this into their current portfolio.
Don’t delay market entry to wait for greater perfection in ESG data
The report indicates, and we agree, that tackling the ESG data challenges as an advisor will be part of your ESG landscape now and into the future. To address this challenge they recommend a few things that you as an advisor should be thinking about when it comes to managing the confusing variance in ESG data.
First, they recommend engaging “more closely with underlying corporates in order to receive accurate and timely data sets and reporting.” Secondly, they recommend looking at and managing more than one data source and leveraging third-party data providers to allow for more accurate visibility.
While the report calls ESG investing an “immature data market”, at OpenInvest we believe that the data isn’t looking to “mature” towards convergence, but rather will continue towards diffusion. However, this isn’t necessarily a bad thing and it’s not a reason to halt your ESG momentum.
ESG data is fundamentally subjective due to 1) how each data provider takes into account scope, weightings, interpolation, and portfolio construction, and 2) the fact that differentiation is rewarded in a competitive market. As an advisor, it’s time to move away from a product-based ESG model towards a more service-based ESG model.
In a service-based ESG model, your data accuracy matters, but the result or impact of the ESG investment is what your client really wants to hear. What are the tangible and relatable impacts of their investment? How many trees did their portfolio save this quarter? How much money towards vaccine development did they invest? And so on. Learning how to manage through the ESG data as an advisor is part of the future of ESG investing, but as we’ve mentioned, should not halt your progress in offering this to your clients.
As you re-bucket the confusing ESG data into impacts your clients can understand, you will also be providing an engaging and customized experience for your clients. By demonstrating the value of personalized service and attention through a focus on the values and issues that matter most to your clients, you are also driving your business forward with increased client satisfaction and retention.
Develop stronger risk management with ESG
As the PwC report indicated and as 2020 has shown us, ESG and climate risk management is going to continue to be a crucial component for any investment portfolio. Throughout the market volatility of 2020, the ESG space tended to outperform the rest of the market with a Bloomberg analysis showing that the average ESG fund declined by 12.2% in 2020, less than half the decline of the S&P 500.
As an advisor, this means that you will need to put an increasing amount of importance on the assessment and mitigation of ESG risk for your clients. The report shares that if you overlook ESG-related risks, this could have “serious reputational and financial repercussions for asset managers in the new landscape.” By evaluating and monitoring your clients’ portfolios for potential ESG risks and exposures, you can remain ahead of the game and potentially avoid future financial repercussions.
As regulatory momentum with a new administration makes this easier and companies are rewarded in the markets for their improved corporate citizenship and transparency around ESG related risks, this will only get easier for you as an advisor. As companies start to realize that becoming more sustainable increases their shareholder value, these changes are also a win for more accessible ESG investing that makes non-financial impacts a priority alongside financial returns.
In conclusion: we are moving towards full-scale ESG integration
The PwC report is indicating that it’s not a matter of if but when the investment landscape will see a total shift where financial and non-financial performance criteria are on a level playing field. As an advisor, even if you are seeing limited demand currently, there is a wave of genuine interest among investors and regulatory momentum around ESG that will make this the growth opportunity for the century.
As we further venture into 2021 and reflect on the past year, it’s clear that this pandemic and other societal shifts and crises have served as validation for what a future sustainable investment portfolio looks like.
The PwC report offers a great look into the growing momentum of ESG, the key catalysts driving this sustained growth, and key actions you can take to stay ahead of the curve. But the main theme is: you cannot be both ESG and non-ESG. As an advisor, now is the time, if you aren’t already, to get on board with ESG. Moving forward, ESG needs to be mainstreamed as a feature of your offerings to clients as opposed to a niche or specialty product.