During the past 12 months, institutional and private investors have realised they want more from their investments than just financial returns.
They want to know their investments are also ‘doing good’ somehow, solving either an ESG issue, such as climate change, diversity or corporate stewardship.
The numbers back this up, with more than $100bn funnelled into ESG-labelled equity funds in 2020 up to mid-October – a 20% increase on the same period in 2019. Similarly, in early December the green bond market reached $1.002trn in cumulative issuance and issuances are expected to hit $350 billion in 2021.
Those who backed ESG investments have also been rewarded with outperformance. The MSCI World index has been beaten by the MSCI World ESG Leaders index and the FTSE Russell FTSE4Good Developed 100 in 2020. A wider delta in performance in favour of ESG strategies was obtained in markets where ESG practises are still undervalued as demonstrated by the MSCI Emerging Markets ESG Leaders performance compared the relative tradition index.
Investor demand and solid performance are clearly beneficial for the ESG industry, but other factors will play a crucial role in its ongoing success.
Not only will every asset manager and wealth adviser need to be able to engage all their respective clients on the issue of ESG, listed companies will be increasingly keen to be identified as businesses that are helping to solve some of the world’s most pressing issues.
When the likes of BP effectively acknowledging that demand for oil is likely to have peaked, and that it is actively shifting its business model to become an ‘integrated energy company’ rather than an ‘international oil company’, the direction of travel could not be clearer.
The European Commission is forging the way with its Sustainable Finance Action Plan and it is likely the US and Asia will follow suit.
Europe’s plan seeks to create clearly defined rules as to how ESG considerations must be factored into investment and advice processes. The election of Joe Biden, who is more sympathetic to climate action goals than his predecessor, will result in something similar.
Progress is already being made by large-scale pension funds in Asia, such as in Australia and Japan, and we foresee more wide-ranging regulations to begin forming in 2021.
Social bonds will go mainstream
We expect the ‘S’ in ESG to become more prominent in 2021. It is undeniable that environmental-related investments have proliferated more rapidly than those from the other two categories until now.
This is partly because environmental goals are ostensibly easier to measure.
But with initiatives like the first Social Impact Bond to designed to tackle HIV/AIDS, launched by the Elton John AIDS Foundation, and other notable issuances, we expect to see social bonds multiply.
Data, data and more data
The maturation of the ESG industry means there is now more data for investors to dissect. And dissect it they will.
The development of the industry just this year presents a wealth of information to scrutinise and will enable fund managers to improve the financial performance of their ESG offerings, as well as more finely tune their risk/reward profiles. But significant more data means increased complexities to deal with.
Race to the top in reporting
The desire to be a sustainable, socially responsible company is atop the agendas of the world’s largest companies.
But many global brands struggle to articulate to shareholders and consumers what it is exactly that they have achieved or aim to achieve.
The race to be the best ESG company – and to produce the most coherent and communicative ESG reports – will drive corporates on in their ESG development. Once companies can articulate and demonstrate with data what their efforts have achieved, their ESG efforts will be rewarded.
Private equity jumps in with both feet
Some private equity houses have engaged with ESG investing but the industry’s embrace of it will need to become tighter in 2021.
The sector will need to fully embed the concept into its investment approach. Failure to do so could make it harder for it to raise money from the likes of large pension fund clients, all of whom are acutely aware of the necessity to be ESG compliant.
Emerging markets booster
ESG-related concerns are just as important for businesses and policymakers in emerging markets.
Progress to date in some emerging economies has been notable and their bold aspirations can sometimes be overlooked.
Many so-called emerging market nations – both developing and developed economies – are relinquishing the grip exerted on the world by Covid-19 more quickly than some western economies.
Their faster recovery from coronavirus, coupled with the desire for investors to access some diversified sustainability plays, could see emerging markets provide yet more support for the ESG asset class.
Everybody wants a piece
Tesla’s valuation is now equal to the combination of all the biggest worldwide automakers, reasonable or not this shows how money is flowing into green regardless of DCF or multiples.
Governments are the main chefs of the green cake, which is becoming bigger and bigger. “We have more proof that what is good for the climate is good for business and is good for us all,” said Ursula von der Leyen when announcing an increase in the existing 2030 emission-reduction target, from 40% to 55%, compared with 1990 levels.
Biden committed in case of victory to unveil a $2trn climate plan and China officialised its climate neutrality target for 2060.
Also, SMEs are starting to taste the cake with banks providing better loan conditions for greener companies or green projects. Off course the risk of eating too much is there but green is easily digestible.