The growth of environmental, social, and governance investing in the past few years has been nothing short of explosive.
While interest in issues like social justice and equality, climate and sustainability, and diversity and inclusion has been growing for a number of years, the pandemic has accelerated awareness on a global scale.
Asset managers have responded with a flurry of marketing activity and product launches to seize the moment. Call this ESG phase one, or 'the great productisation'.
So far they have been quite successful: ESG portfolios in Europe and the US attracted record inflows in 2020. When compared to the outflows experienced by most managers in their actively managed portfolios, the growth looks even more impressive.
Yet there is an even bigger opportunity at hand for asset managers. This next phase of ESG could be characterised as 'the great consultation': offering strategic ESG advice and expertise to big investors.
Many large institutional investors recently have made public commitments to meeting ESG standards, most notably around the environmental (E) component.
Among the highest-profile efforts is the UN-Convened Net Zero Asset Owners Alliance, or NZAOA. Launched in 2019, the group comprises asset owners from around the world with nearly $6tn (£4.2tn) of the world’s wealth.
Together they have pledged that by 2050 the carbon emissions of the companies in their investment portfolios will be net zero, a key tenet of the 2015 Paris climate accord.
The NZAOA is significant because these investors have voluntarily put themselves on the hook, and indirectly have put pressure on their peers as well. Recognising that they will be scrutinised to see if they make good on their promises, many have started making changes to their portfolios where they can.
But the activity has been spotty, and the low-hanging fruit has often already been picked. Taking the next steps will be harder.
And therein lies the opportunity for asset managers.
Managers must up their game
In ESG phase two, leading asset managers will raise their game. They will not just offer climate-friendly products or roll out new ESG screening services that help clients feel good about their investments.
Instead, they will become climate change consultants, advising their clients on how best to transition their portfolios to meet the lofty commitments they have made, while still achieving their return objectives and satisfying risk constraints.
Balancing all these objectives is not easy and will only become more challenging over time. The most forward-looking asset managers will offer genuine, climate-expertise-based solutions that can not only inform how they make their own investments and structure better investments for clients, but also help clients with their transition to net zero as well.
We are seeing these capabilities start to bubble up in the marketplace, with some asset managers aligning in joint ventures with climate specialists and others creating their own climate-science risk management platforms.