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Investors want choices that reflect their values without sacrificing returns. A solid understanding of data management, regulations and technology is key.
ESG: DISPENSE WITH THE MYTHS AND FOCUS ON PROGRESS
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contents
Progress: Technology
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Progress: Reporting
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Progress: Regulations
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Myth: Data dearth
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Myth: Poor performance
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ESG innovation
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ESG explosion
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Now valued at around $30 trillion, some estimate that global ESG assets are on track to exceed $100 trillion by the end of this decade, which would make up 95% of all total managed assets. Millennials, to a large degree, have influenced this movement. Powerfully driven by their values, they’re inheriting vast sums that measure in the trillions. Their collective convictions about issues such as carbon emissions, human rights and corruption have created a tremendous ripple effect throughout the entire investment community, including hedge funds and their younger and older counterparts are following suit. Currently, Europe accounts for half of global ESG assets, but the U.S. has shown the strongest expansion this year and is likely to dominate the category beginning next year. The next wave of growth could come from Asia, particularly Japan. The potential rewards for hedge fund managers and their clients are monumental, and so are the payoffs to the environment, society and business.
ESG EXPLOSION
ESG Assets
DID YOU KNOW?
of hedge fund managers believe they will see increased demand for ESG-integrated investments.
ESG assets as a percentage of total assets under management
Total Assets
0
2018
2021f
2030f
Source: Deutsche Bank (future), Global Sustainable Investment Alliance, 2018
of millennials
are “interested” in sustainable investing vs. 49% of the total population.
Source: BNP Paribas Hedge Funds Survey, 2021
Source: Morgan Stanley, Sustainable Signals, New Data from the Individual Investor, 2019
%
Why is environmental investing important?
The “E” in ESG gets the most attention, given the wow factor of environmental innovations. Everything from ocean clean-up, 3D-printed houses and drone farming to animal-free meat substitutes and smog vacuum cleaners dominate the news. Just as important is the “S,” or behavior that affects respect for and protection of people. Examples include the sock manufacturer that donated 10 million pairs to homeless shelters and the shoemaker that gives one-third of annual net profits to grassroots efforts to create change. The “G” seeks to curtail the poor corporate behavior that’s often at the core of corporate scandals, such as the car manufacturer that equipped vehicles to cheat on emissions tests or the social media giant accused of misusing data. Incorporating all three components – E, S and G – into your portfolio can help attract investors with wide-ranging values. Equally, you have to make sure to include all of the elements into your own scoring and reporting, too. Investors want to feel good about the companies they back. Hedge fund managers can oblige their clients – and maximize returns, too.
ESG IS MORE THAN JUST THE “E”
Millennials represent an important market for hedge fund firms, and this segment is powerfully supportive of corporate efforts to reduce the carbon and pollution that poisons our environment.
Corporate entities with business practices that treat people equally and with respect will ultimately be rewarded in terms of profits – the market will ensure it.
Why is social investing important?
Paul Livanos, senior business development manager for Buyside, FIS
Trevor Headley, vice president and product management executive for Hedge Funds, FIS
Scott Alintoff, senior vice president and group executive for Product Management, FIS
Reasonable executive packages and corporate behavior that’s above reproach – it all points to management excellence, which is so important to investors. So, the example these companies set will, in the end, lead to their success.
Why is governance investing important?
Many asset managers and investors still buy into the myth that ESG generates lower returns. Perhaps that was once the case. Now there is a growing recognition that integrating ESG into investing is more than the right thing to do. Increasingly, research shows that sustainable investing outperforms investments based purely on financial metrics. By far, the most common approach is to incorporate ESG into investment strategies alongside traditional financial metrics with the express purpose of increasing returns while lowering risks. Another approach employs the exclusion of objectionable investments such as tobacco. Still others practice impact investing, which aims to solve specific environmental or humanitarian problems. At any rate, companies with better ESG standards are expected to record stronger financial performance and beat their benchmarks. With growing evidence that ESG investing improves performance, how can you find the right strategies for your clients?
MYTH: POOR PERFORMANCE
Three approaches to incorporating ESG into investment strategies
ESG integration
65%
Exclusions
49%
Impact investing
Source: Hedge Funds Lag Behind Peers on ESG Investment Factors – Bifinance, IPE, April 2021
Over the next 20 years, of asset owners expect that ESG integration will be positively associated with hedge fund outperformance.
Source: BlackRock Global Client Sustainable Investing Survey, July-September 2020
6 ESG data challenges:
It wasn’t long ago that only a handful of ESG investment options were available. Today, a multitude are out there, but the industry’s ability to arrive at consistent data collection and standardized reporting hasn’t caught up. This makes it especially difficult to root out companies that practice greenwashing; that is, conveying the false impression that their products are ESG-compliant. But changes are on the way – for example eco-labelling, a certification that identifies environmentally preferable products and services. New technology and data-driven methods are emerging to make gathering and processing data easier and cheaper. Robotic process automation, machine learning and artificial intelligence will play an important role in synthesizing traditional and non-traditional data and enabling ESG scoring, methodologies, taxonomies and reporting frameworks. Performance is accelerating and the amount of ESG-specific data is increasing. How can you be sure your portfolio choices will stand up to regulatory scrutiny?
MYTH: DATA DEARTH
Lack of point-in-time datasets and delays between disclosure and availability
1. Timeliness
Lack of clarity about methodology, especially around materiality
2. Transparency
An insufficient number of metrics, as well as significant data gaps (geographies, asset classes and ESG components)
3. Coverage
Limited consideration of forward-looking management plans or changes in behavior
6. Backward view
Data collection, aggregation and modelling of data based on subjective assumptions
5. Subjectivity
Errors in vendor data processing and too much reliance on self-reported company data
4. Integrity
Source: Celent, Sustainability in the Capital Markets, July 2020
Today, 80% of corporations conform to the 2000 Global Reporting Initiative, and more than 7,000 signatures are in place for the UN Principles of Responsible Investing. Nearly 200 governments have signed the UN Paris Agreement aimed at reducing global greenhouse emissions to net zero by 2030. The result of these initiatives has been the issuance of an array of regulations, including the EU’s Sustainable Finance Disclosure Regulation. But even more regulations are needed to set standards in place. Future legislation will ensure that everyone is abiding by the same rules, which equips hedge fund managers to prepare a credible presentation of viable ESG investment options that are backed by legal mandates. Furthermore, it will give investors’ confidence that their investments are being directed appropriately and they’re making a real difference. Growing regulatory guidelines promise to bring accountability to ESG investing, but how do you know your investment options are abiding by the rules?
Source: Principles for Responsible Investment (PRI), 2020
new or revised ESG policies were issued in 2020 – the highest to date and a 35% increase vs. 2019.
increase in the number of asset owners, investment managers and service providers that are signatories to the Principles for Responsible Investment in March 2020, compared to 2018.
Source: Signatory Directory, 2020
Reporting of ESG practices is still relatively uncommon and the information disclosed lacks consistency. As stakeholders embrace ESG investing, however, companies can see the benefit of proclaiming their good deeds. The rise of ESG regulations has influenced reporting, with notable guidance coming from the European Commission, World Economic Forum, Carbon Disclosure Project, Climate Disclosure Standards Board and others. This will help ensure that all companies report the same way and encourage standardized scoring of ESG credentials. But official input on standards, ratings and indexes keep evolving and greenwashing is still a concern. All this can be confusing, but if you understand how ESG reporting frameworks bring value, you can increase your own credibility, build a competitive advantage and convey a compelling story to investors. As standards remain undefined, how can technology help you digest and use ESG-related data to pinpoint viable and compliant ESG investment strategies?
PROGRESS: REPORTING
Europe has the most reporting provisions.
Source: Governance and Accountability Institute, Inc. (G&A Institute), July 2020
of companies in the S&P had already published their annual corporate sustainability/ESG reports as of July 2020 – an all-time high.
True or false?
true
False
Europe has 245 provisions, followed by the Asia Pacific with 174.
Source: GRESB, The Future of ESG Reporting, Schneider Electric, May 2021
You need sophisticated tools to make sense of the enormous amount of data being generated from every corner. Platforms with automated workflows simplify the inclusion of mushrooming global regulations. Most of all, qualified expertise can position you competitively as this new reality unfolds. Leading technology providers are rising to the challenge. An important part of hedge fund system modernization is leveraging the power of AI and machine learning to aggregate, digitize and analyze data and quickly communicate opportunities to investors. Emerging front-to-back-office solutions support the entire investment life cycle, from trade screening to order sizing, portfolio optimization, compliance and reporting. In many cases, ESG investment management will be available on a BPaaS basis so that hedge fund managers can outsource day-to-day tasks and focus on their sustainable strategy. Modernized technology is the key to unlocking the insights that lie within the required and voluntary data flooding the market.
PROGRESS: TECHNOLOGY
Hedge funds that prepare now will be the first to build credibility, enhance their brand, form stronger bonds with clients and attract investment dollars from lucrative new segments.
Let's solve sustainable investing
Despite the complexities, the myths surrounding ESG investing are fading – and real progress is underway to standardize, regulate and automate ESG investing. Not surprisingly, technology is playing a major role in achieving aggressive environmental, social and governance goals. At the same time, it’s helping hedge fund managers navigate their way toward high returns, satisfied clients, organizational growth and a competitive advantage.
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