ESG Investing  

Sustainability should be reflected in product and strategy development

Rhodri Preece

Rhodri Preece

From climate change to Covid-19, 2020 highlighted the inextricable links between finance and the wider societal and environmental ecosystem.

It also vastly accelerated the sustainability trend in investment management. A broader understanding and application of systems thinking is now needed if the sustainability paradigm is to evolve into the mainstream of investment management.  

It is rare for a single topic to challenge such long-held theories and investing paradigms all at once, yet this is the challenge of sustainable investing, and it goes to the heart of the sustainability of investing.

There are two important issues underlying this sustainability trend. Firstly; a growing awareness of the financial materiality of climate change issues, and secondly; changing societal expectations around how companies manage social issues such as the treatment of workers, customers, and the supply-chain in a multi-stakeholder model.

These considerations preceded the Covid-19 pandemic but were accentuated by it. 

Growth opportunities

The premise of sustainability is that financial benefits which provide for consumption and intrinsic needs have higher utility if the environment in which they are consumed is sustainable.

It follows that the interests of the investment profession and its clients are better served by incorporating sustainability into business and investment models.

A key driver of the growth in sustainable investing is client demand. According to recent CFA Institute research, although only 19 per cent of institutional investors and 10 per cent of retail investors currently invest in products that incorporate environmental, social, or governance (ESG) factors, 76 per cent of institutional investors and 69 per cent of retail investors have interest in ESG investing. 

Preferences and motivations for ESG investing vary across generations, geographies and societal segments, but generally there is greater demand for product personalisation and alignment of investments with personal beliefs. 

The future growth opportunities in the sustainability product space include ESG thematic and impact products, ESG multi-asset products, climate transition strategies, and better benchmarks.

To achieve these aims, sustainability should be reflected in the governance surrounding the development of new products and strategies, including client reporting, disclosures, and incentives.

A recent CFA Institute survey found that values-based objectives - a desire to express personal values or invest in companies making a positive impact on society or the environment - are the primary motivation for ESG investing among retail investors.

This reflects a paradigm shift where investment objectives involve balancing risk, return, and non-financial impact.

The understanding and measurement of impacts, both financial and non-financial, is central to systems thinking.

Systems theory recognises the interconnectivity and reflexivity between corporate value creation and the wider ecosystem.

A deeper understanding and modelling of these interconnections can enable a better assessment of investment risks and opportunities over different time horizons.