The other issue is that investors are increasingly questioning the usefulness of ESG data. What does an ESG score really mean anyway? We are going to see investors asking for harder numbers and metrics delivered in more meaningful and familiar ways. For example, investors understand carbon emissions, so it will be more helpful for them to get a hard number tied to an entity’s carbon emissions rather than an ESG score.
2. Rise of ESG Thematic Funds
Investors are becoming more sophisticated about ESG investing, and as a result there will be a move away from generic ESG funds, which are also ripe for greenwashing, towards more specific thematic options such as gender parity or low carbon.
3. Regulatory Regime Will Increase Focus on ESG
Europe has shown real leadership on the regulatory front on a range of issues, but particularly with respect to greenwashing and investors’ disclosures. In the US, the Biden administration has sought to roll back some of the proposed ERISA guidance, with proposed amendments to broaden the notion of fiduciary duty to include ESG factors. We can expect the regulatory regimes across both continents to scale efforts with an increased push on a host of issues from better measurement to greenwashing to marketing oversight.
4. Further Evolution Away from Traditional ESG Equity Investing
Much of the talk about the need to scale ESG investing ignores a fundamental hurdle: currently you can essentially only find ESG options for one part of your book. The large majority of ESG fund offerings remain long-only, equity-centric portfolios. What’s more, the narrow focus of the current offerings also raises the prudent investor assessment of risk-return. Whether equaling or underperforming their benchmarks, most ESG offerings carry full exposure to procyclical equity beta risk. Their portfolio construction limits ESG investor governance ideals as it limits institutional investors’ ability to achieve a high level of diversification in its ESG-conscious capital allocations. We’ll expect to see more investors push their investment managers for additional sustainable options. We believe pensions, in particular, will come under greater pressure to develop a multi-asset approach to ESG investing.
5. All Eyes on Europe
Without question, the US attendance at COP26 signaled their intention to recommit the country to the global climate agenda. But expectations are muted as to how much the US will be able to accomplish given political winds at home. Therefore we can expect the private sector to be driving much of the sustainable agenda in the US rather than the policy makers. In the meantime, expect Europe to continue to fill this void. Not only have they led for years on the governance front, but also on the regulatory front. Look for continued evolution of the Sustainable Finance Disclosure Regulations (SFDR) and ongoing enforcement actions to clamp down on greenwashing and boost accountability.