A report by PwC Luxembourg has predicted that by 2025 more than half of total mutual fund assets in Europe could be sitting in ESG-focused funds as the it labels ESG the “largest fundamental change in the investment landscape since the introduction of ETFs”, as reported by ESG Clarity in the UK..
According to the report, entitled The Growth Opportunity of a Century, European ESG assets could reach between €5.5trn (£5trn) and €7.6trn by 2025, making up between 41% and 57% of total European mutual fund assets, up from their current proportion of just 15.1% (as of the end of 2019).
As of the end of 2019, Europe has the highest share of ESG fund assets worldwide, accounting for 69.4% of the $1.66trn of global ESG fund AUM, followed by North America (20.9%), Asia-Pacific (8.2%) and MEA, Africa and Latin America (1.6%), according to the report.
For this report, PwC surveyed 200 asset managers, 300 institutional investors with European operations, and over 800 European retail investors, representing an estimated $14.3trn (£11trn) in AUM.
Following in-depth interviews with these participants on the topic of what direction they believe the industry is heading, PwC came to the conclusion that ESG will be “the fastest growing area within the industry this decade”, driven by four key catalysts: regulation, outperformance of ESG funds, growing investor demand and societal shifts, highlighted by Covid-19.
Olivier Carré, financial services market leader at PwC Luxembourg, said: “Public awareness of ESG related risks, major regulatory change and institutional investors preferences are rapidly pushing ESG investing to the top of the asset management agenda. The combination of these trends has brought the European asset and wealth management industry to the brink of an imminent paradigm shift.”
The four catalysts
PwC said regulatory pressures are “arguably the primary differentiator which cements Europe as the global leader in the ESG space”, with a number of core new regulations coming in from 2021 putting further pressure on financial market participants to integrate ESG across their businesses.
It said the upcoming regulations will oblige fiduciary investors to turn to ESG; spread good governance along the investment chain; and implement new disclosure requirements at both a product and an entity level.
Meanwhile, PwC expects the performance gap between ESG and non-ESG products to widen significantly in the future, saying “ESG products will emerge as a stronger source of returns and downside protection with respect to their mainstream equivalents”.
“Our analysis shows that ESG-aligned funds cumulatively outperformed their traditional counterparts by 9% over a period from 2010 to 2019,” the report said. The Covid-19 pandemic has highlighted the resilience of ESG funds even further.
As a result, it is no surprise that more and more investors are turning to ESG, with flows into European ESG products in 2019 representing 19.8% of their total AUM, while non-ESG fund flows only accounted for 3.8% of AUM.
“These strong inflows persisted throughout the Covid-19 crisis, with investors allocating a record-breaking volume of assets to the ESG funds during the pandemic,” PwC said.
The firm predicts the pandemic and the subsequent market downturn will “catalyse the shift in society’s awareness of ESG issues”, which will further support the case for sustainable investment as it shines a light on the impact of ESG risks on the entire global economic system.
Its survey reflects this view, with 97% of respondents saying the pandemic will impact their ESG approach in the future.
Michael Baldinger, head of sustainable and impact investing at UBS Asset Management, said: “The game-changer in 2020 has obviously been Covid-19. And in the aftermath of the pandemic we wouldn’t be surprised if regulators choose to intensify their scrutiny on the ways in which ESG risk more broadly are integrated within the investment process.”
In fact, according to the report, the industry is at a turning point where ESG and non-ESG products will begin to converge as fund providers find it increasingly more difficult to sell non-ESG funds – some 94% of respondents to the survey agree with this view.
“We believe that investments into ESG and sustainability will bring about a fundamental restructuring of the investment landscape, changing the very nature of the industry from the ground up,” the report said.
A vast majority of European institutional investors expect this convergence to take place as early as 2022, with 77% of them planning to halt purchasing non-ESG products that same year. However, only 14% of fund providers plan to stop offering non-ESG products by 2022.
Meanwhile, the report also identifies seven key actions that managers should consider from both a strategic and operational perspective to take advantage of the opportunities offered by the explosion in ESG demand.
These include repositioning your organisation, being credible and consistent in your ESG approach, integrating ESG at a product level, tackling the ESG data challenge, developing a strong ESG risk management framework, reporting to investors and educating the investment community and staff.
Carré commented: “We expect that the [asset and wealth management] industry of tomorrow will be different from today, with ESG considerations becoming a standard for investing at a level playing field with the traditional financial yield standards.
“This shift represents a once-in-a-century opportunity – not only for the industry, but for the future development of Europe as a continent.
“As global capital becomes increasingly channelled towards sustainable projects, Europe is well positioned to act as the global ESG hub – creating new jobs and opportunities and thus enhancing the prosperity and future life quality of its population.”