The growth in ESG investment is widely seen as one of the more obvious, positive trends in investment markets over the past decade. However, pension plans, insurers and the consultants who advise them, may be held back by less-financially conscious investors willingly supporting ground root projects, reducing the role that asset owners can play.
The recent gathering of asset owner opinions for the annual Environmental, Social & Governance Investing report, uncovered that pension plans and insurers were largely looking beyond the obvious ESG investment opportunities serviced by international development bodies. Most were seeking the obvious: businesses that displayed good value, long-term qualities. Interestingly though, increasing numbers were making selections not based solely on the obvious financial returns but on evidence provided by proprietary models that take into consideration probable cultural and societal trends that their investments would offer risk protection and long-term returns, should they come to fruition.
The role that consultants have played in leading asset owners towards ESG approaches was seen by most we interviewed as, at best, questionable. The result was that consultants have largely been cut out from ESG related discussions, due to a lack of pro-activity to put forward such investment opportunities. Many put this reluctance down to the difficulty to quantify return expectations, plus lower short term returns many ESG investments offer compared to non-ESG investment areas. Consultants have simply been acting to the laws of supply and demand: reluctant to use the precious time they have with clients talking about an investment area that generates low fees and a higher benchmark to sell in.
Consultants can be forgiven though, given that many of the best ESG related investments are often held back by scale and cost of due diligence comparable to the short to mid-term returns expected; some good ESG investments are simply not big enough for their clients.
One solution to identifying great ESG related opportunities, has been the development of proprietary ESG models, allowing asset managers to identify added value where other less sophisticated investors may struggle. Increasingly at the core of many of these proprietary models is the sensitivity to business that have shown high levels of profitability on the back of a resource intensive business model. Given the increased sensitivities to ESG factors, these businesses are seen as at a long-term disadvantage, to be pulled back in the coming years as consumers and business become less inclined to interact with them.
Likewise, proprietary modelling has tackled one of the other emerging problems faced by many ESG investors (something I wrote about in a previous article): falsely labelled investments. Given the inclination and pressures many asset owners face to include some elements of ESG investments into their wider portfolios, businesses and project owners have taken advantage by dubiously marketing their investments as complimentary to such trends.
What many of these proprietary models are based on is the assumption, the long-term economics of ESG issues transcend day-to-day erratic behaviour and provide clarity on ‘substance’. Unlike other forms of investment modelling, the implementation of ESG considerations simply does not need to be financial in nature, the ability to mitigate future risks is the investment case in itself.
The Environmental, Social & Governance Investing report is released 10th April. To request a free copy, click here.
Post by Noel Hillmann, Founder & Managing Director, Clear Path Analysis