A number of variables have helped drive flows into environmental, social, governance (ESG) orientated fund products across multiple asset classes. Institutional investors are facing pressure from their end stakeholders – often younger millennials – about having exposures to instruments or securities which are contrary to their moral or political compasses.
Pragmatism is also playing a major role. While it makes for nice PR when a sovereign wealth fund divests from a carbon-heavy industry, the decision is often derived from investor recognition that pollutant sectors are facing disruption from innovations in renewables, while some environmentally unfriendly activities and practices may be outright banned by governments in years to come.
Despite these advances, one of the biggest problems for ESG, however, has been its data. Qualifying outperformance at ESG linked products relative to other investment vehicles has always been difficult, because the concept and variables deployed are very new. However, Chirag Patel, head of innovation and advisory solutions for EMEA at State Street Global Exchange, believes this is changing.
“The quality of data for listed equities and fixed income has been strong and there is an abundance of information about their ESG credentials making it straightforward for investors to build up exposures in such assets. Providers using sentiment-analysis techniques are helping further improve the quality and frequency of data for listed assets,” said Patel.
He continued: “In addition, we are now seeing improved ESG data collection in unlisted assets. ESG attributed assessments for unlisted assets are often performed on a bottom-up, project-by-project basis, and it is helping investors incorporate ESG considerations into their alternative allocations such as private equity and infrastructure exposures.”
Building ESG products for diverse investor bases is not easy. No two clients are the same. A religious organisation may – for example – wish to exclude alcohol, gambling and other sin stocks from portfolios whereas an environmental foundation may have very different tolerances for such exposures. Creating a standardised template for ESG disclosures by listed firms, while difficult to achieve, may help alleviate this challenge.
Initiatives by the UN PRI and the Sustainable Accounting Standard Board are in motion to create reports which are consistent and easily comparable. Whether these schemes are successful is another question, although given the range of investors in the ESG space, it is highly probable that even with standardised disclosures, ESG products themselves will continue to be fairly bespoke. “ESG product development is going to be very hard to standardise and likely to be tailored to specific client requirements,” said Patel.