The future of ESG in investment

Last year, the global association of investment professionals, the CFA Institute, launched its first ever ‘Certificate in ESG Investing’.

Its instigation is an indication of the priority ESG now holds for the future of investment.

The course covers all the following and is applicable to all asset classes:

• Analysis, valuation and integration of ESG factors

• Constructing and managing ESG integrated portfolios

• Investment mandates, portfolio analytics and client reporting

Will Goodhart, chief executive at CFA UK, said: “CFA Institute’s adoption of the Certificate in ESG Investing is a clear sign of … the global demand for access to skills and knowledge related to ESG integration.”

Over the last decade, ESG has gone from fringe to mainstream.

And today, it is not just fundamental strategies that are prioritising ESG integration. Quantitative investment strategies are now assimilating ESG factors into their valuation models and investment decisions too.

Quantitative traders now harnessing ESG integration are building models that integrate ESG factors alongside other weightings, such as value, size, momentum, growth, and volatility.

It means ESG data and/or ratings can be fed into the quantitative investment process so that the weights of securities can then be adjusted upwards or downwards.

The growth in ESG as an investment focus is a reality that has implications for all investment portfolios.

There is a growing acceptance that many ESG factors are now economically material, especially in the long term, and that is now incumbent on the investment industry to integrate ESG factors across their investment decisions.

Soaring sophistication in stakeholder understanding of ESG means that decision-makers will now have to be ready for a greater depth of conversation when managing portfolios.

The market for ESG funds set a record in 2020 and continued to grow in 2021. In total, an estimated $120 billion flowed into ESG exchange-traded funds.

So what are the investment trends in ESG right now?

1. Non-acceptance of greenwashing: Investment groups whose commitment to environmental, social and governance analysis is superficial will suffer. Investors want reassurance that fund groups have really done their homework.

2. Carbon+: With carbon targets now well-defined, attention is expanding to broader biodiversity targets, including methane reduction – all priorities that have come out of COP 26.

3. ESG common standards: A recent report from Morningstar reveals that there were at least 34 regulatory bodies and standard setters across 12 markets undertaking official consultations on ESG in 2021 alone. Says Matthieu Guignard, global head of product development and capital markets at Amundi ETF, Indexing & Smart Beta, says: “We anticipate an ESG regulatory ‘revolution’ for 2022 and early 2023 with the implementation of taxonomy and Sustainable Finance Disclosure Regulation (SFDR) coupled with the introduction of ESG preference for investors with MiFID2… not forgetting the revision of BMR.”

4. More focus on the ‘S’ and ‘G’: General corporate behaviour is now under scrutiny, as well as employee welfare, health and safety, and diversity and inclusion. There is a greater interest in how staff are being treated as well as those working in the supply chain.

Perhaps the biggest ESG revolution is happening in the US where it is waking up to responsible investment and on the demand side altering the picture dramatically.

In the global marketplace, the UK and Europe are the minority customer base, but where the US goes, they will follow.

According to the latest edition of the Global Sustainable Investment Review, sustainable investment assets continue to grow in most regions, with Canada experiencing the largest increase in absolute terms over the past two years (48% growth), followed by the United States (42% growth), Japan (34% growth) and "Australasia" (25% growth) from 2018 to 2020.