It is little wonder people remain confused around the concept of Environmental, Social and Governance (ESG), or responsible investing.
recent report, Your Planet, Your Future, from asset managers Amundi Ireland, revealed that most Irish savers – 89pc – do not know what ESG stands for.
Also, most are unsure what the term ‘responsible investing’ means, associating it with investing cautiously, rather than investing in endeavours that aim to do right by people and the planet.
These gaps in knowledge exist, even though Irish savers also say they want to be able to invest in greener products, with 86pc of those surveyed about pensions, investments or savings products saying they considered ESG important.
In fact, half of the 1,000 people surveyed said they would be willing to sacrifice up to 10pc of their return on their investment in order to help the planet and avert climate crisis.
Essentially, ESG is a collective term for a business’s impact on the environment and society, and how robust and transparent it is when it comes to corporate governance – in other words, how it operates and treats its staff and stakeholders.
Clearly, as an industry, investment managers need to do much more when communicating to investors.
Existing confusion compounded by recent events
This existing confusion around responsible investing is likely to have been compounded with recent news that nearly a quarter of funds claiming sustainability credentials under the Sustainable Finance Disclosure Regulation (SFDR) are not living up to ESG investing principles, and don’t warrant the EU’s Article 8 ‘green’ classification.
Effective from March 2021, EU Directive SFDR, requires financial market participants – such as asset managers and financial advisers – to provide investors with certain ESG-related information about financial products, to enable them make informed investment decisions based on ESG factors.
Under this new regulation, financial products are separated into three different categories:
Article 6 – which are, in essence, financial products that have no sustainability drivers;
Article 9 – which are the most ESG-friendly products – items with specific ESG objectives, only investing in sustainable investments. Article 9 funds are considered ‘dark green’ due to their core sustainability focus;
Article 8 – which are somewhere in the middle. Funds categorised as Article 8 are meant to promote environmental or social characteristics, or both.
However in recent weeks it has been revealed that some 23pc of funds classified as Article 8 have been deemed unworthy of the classification, according to research from Morningstar, a leading global research and data firm.
Additionally, a number of Article 9 funds were also reclassified or ‘downgraded’ to Article 8.
Added to the confusion caused by ambiguity or interpretation around key regulation is the persisting problem with gathering accurate and real-time data to make ESG investment decisions.
Data can be subjective
Data is at the core of ESG investing and it is currently imperfect. A recent Accenture report identified that one of the most significant barriers to ESG integration is the lack of quality, consistency, and reliability of ESG-related data disclosure, along with coverage and data gaps.
There are only about 30 data vendors with experience in this area, and of those only a small number provide global coverage.
While we are seeing more companies pop up, their quality and coverage remain issues for asset managers and investors.
Even one of the leading data vendors, Sustainalytics, believes sustainable investment calculations under current EU regulations “remain perplexing for ESG investors”.
However there is some good news for investors.
SDFR is a first-of-its-kind regulation, and it was introduced to make it easier for investors to compare ESG products across the market. But, like many trailblazing ambitions, it is not without challenges and will take time to fully bed down.
It was largely designed to tackle ‘greenwashing’ – the phrase given to misleading environmental claims that overstates the ESG or sustainability-related aspects of a financial product or company.
Greenwashing can be intentional or unintentional – but the net effect is that investors are misled. Greenwashing can take many forms – selective disclosure, deliberately vague statements, and unsubstantiated claims, to name a few.
In effect, what is happening now – with funds being voluntarily reclassified, and warning lights identifying those not meeting the mark – is that new regulations and increased scrutiny are weeding out funds that are inappropriately labelled ESG.
ESG funds perform better over time
It is now also broadly accepted that companies which operate with strong ESG outperform others in the stock market over the long term – and sustainability information is relevant for understanding corporate performance and investment returns.
Research from McKinsey analysing 2,000 academic studies found that 70pc of them see a positive relationship between strong ESG performance and financial returns. This concurs with findings from a recent report from ESMA, which revealed that over the 10-year period ending in 2020, funds with an ESG strategy (including equity, bond and mixed funds) outperformed their non-ESG peers.
Bloomberg Intelligence has reported that global ESG assets are on track to exceed $53 trillion by 2025 – representing more than a third of the $140.5 trillion in projected total assets under management.
That projection has now been revised upwards, as ESG assets are expected to hit $41 trillion this year. (ESG assets surpassed $35 trillion in 2020, up from $30.6 trillion in 2018, and $22.8 trillion in 2016.)
The trend is clear. People want to invest in companies doing the right thing – despite worries of global recessions, rising interest rates, wars in Ukraine, inflationary pressures, and rising energy prices.
This means that it is more critical than ever for the industry to clearly articulate the challenges and opportunities of ESG investing.
The investment managers here in Ireland are serving people at home and all around the world. Total assets in Irish pension funds invested on behalf of Irish citizens, added to savings in banks and credit unions from Irish households, accounts for €273bn of the total €4 trillion in investment funds which are domiciled in Ireland.
It is clear we have a critical role in ensuring the global investment industry communicates more effectively the core message of responsible investing, while providing ESG products that have a positive impact on society and produce returns for investors
Michael D’Arcy is CEO of the Irish Association of Investment Managers