Investment in companies that integrate environmental, social and governance factors continues to gain traction across public and private markets.
Once considered a niche, the zeitgeist has gone past the notion of a ‘seismic shift’. Instead, integration of ESG underpins most, if not all, debates about the future of the investment industry.
This aligns with broader commentary on stakeholder capitalism, new forms of corporate governance and an understanding of corporate purpose.
Two prominent investment themes over the next decade will be the integration of ESG across portfolio management and corporate business models, alongside artificial intelligence resolving many of the challenges in achieving the former.
While the industry contends with the concept of ESG, from the known to the unknown, there are several structural shifts at play that investment managers must contend with.
Thematic funds are here to stay
Historically, larger investment managers were concerned about a notable diversification of their investment offering. Thematic funds became the flavour of the moment and were explored to take advantage of long-term momentum and market cyclicality.
Trends in sectors such as consumer non-discretionary, healthcare and financials have been very popular with thematic managers who saw value in focusing on a sector and matching the investment horizon of institutional and private clients exposed to equities.
ESG was likely of little concern at the time. Not too long after, and potentially coinciding with the rise of passive investing, diversified offerings began to seem scattered and unmanageable.
Larger houses found themselves in situations where the need to standardise overtook their desire to offer diverse products.
Their clients appeared to have too many options to choose from, at a time when investor appetite began to turn risk averse. Many investment managers adapted by incorporating impact themes to re-introduce a new set of thematic funds that focused on ESG.
Passive indices support ESG investing
The growth in benchmark offerings by index providers is giving a clear advantage to passive investors tracking the index. The Domini 400 Social Index (now, MSCI KLD 400 Social Index), was launched 30 years ago. Today, there are more than 1,000 ESG indices.
However, passive strategies have been slow to react to the growing importance of ESG, leading to potential reputational challenges. Without including ESG-specific factors in passive strategies, the growth in ETF investing over the past 20 years has resulted in major providers becoming some of the world’s largest investors in carbon-intensive industries.
This has not escaped the attention of environmental activists. To address this balance, there has been a recent deluge of new ESG passive strategies launched to market. Despite this, it will clearly take some time, and asset flow, before passive investing can escape this undesirable association.
Sustainable investing goes mainstream
Career analysts may breathe a sigh of relief that one of the two biggest emerging themes in the current landscape is a familiar opportunity to stay relevant. Investment managers who treat this as another temporary change in investor appetite could find themselves left behind.