The fifth and final asset management trend for 2011 that I flagged here is the increasing importance of ESG. This refers to the practice of considering environmental, social and governance factors as part of the investment process. Examples include climate change/ risks, energy consumption, sustainable development, human rights and workers’ rights, fraud, corruption and executive pay.
Wow! You might say. Really? How amazing. Investors are going to consider what’s good for the planet and broader community? What came over them? And how do you square that with the completely short-sighted and selfish value destruction perpetrated by financial institutions and governments in 2008? Fair enough.
There is no doubt that institutional investors’ commitment to ESG has been inconsistent, correlated to large natural disasters (greater interest in the wake of significant events – check out MSCI’s cool chart above), regionally distinct (investors in Europe are far more committed to ESG investing than U.S. investors), and at times has appeared, more ‘pulled’ by political action groups/ shareholders and bloggers, than value-driven.
But that is changing.
There are three key developments driving a sustainable program of ESG adoption by investors. First the intellectual foundations for ESG adoption have been laid. The concept of ‘sustainable development’ that came out of the UN’s work in the late 80s and early 90’s has been influential in this regard. It helped popularise the notion that global economic development should meet the needs of the present without compromising the ability of future generations to meet their own needs.
As investors have become more comfortable with this concept they have become less worried about the short-term cost of implementing an additional layer of (ESG) risk-management. Now you are more common to hear the opposing argument from trustees, ‘how can we afford not to consider the potential impact of ESG developments on our portfolio?’
Through the last decade this concept permeated the way trustees think about portfolio management. The law firm Freshfields published an extremely influential report known as Fiduciary II for example, which made the case for asset managers owing to investors a legal duty of trust, to consider the ESG impact of investment decisions.
Second, an institutional framework is coming together with the help of the United Nations Environment Programme, public interest groups like CERES, industry bodies like the Private Equity Council, and an ever growing group of European pension funds and a smaller but influential group of American investors like CalPERS, CalSTERS and leading private equity firm KKR, many of who have signed on to the UN’s Principles of Responsible Investment.
Third, an investment philosophy and process for investors and asset managers to think about and implement ESG risks at the portfolio level is emerging. Check out MSCI’s excellent white paper for a detailed overview.
Whichever way you look at it, Europe is ahead of the U.S. in integrating ESG and is winning the lion’s share of ESG mandates. Research from State Street Global Advisors for example shows that European asset managers are responsible for more than $7.2 trillion of an estimated $10.9 trillion in ESG assets globally.
Ultimately this is the key point to understand. American firms have competition hard-wired in their DNA. The cutting edge of the asset management industry is moving swiftly ahead to meet integration issues encouraged by a gathering coterie of investors, investment consultants and public sector bodies. As the industry wakes up to the size of the (lost) opportunity it will respond with vigor.
Check out a much more detailed post of this article and full list of sources/ references here.
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