ESG investing is a type of investment decision making that considers environmental, social and internal governance criteria alongside financial returns.
ESG assets are a trend that has gained momentum and is on track to exceed $53 trillion by 2025, representing more than a third of the projected global total assets under management (Bloomberg 2021).
In short, with this growth and industry leaders like BlackRock considering it a central part of their investment strategy, ESG is the investment ‘hot topic’ of 2022.
This article will cover the most common ESG investment strategies and explore what they will look like in 2022 and beyond.
What are the common approaches to ESG?
Although typically described in one category, ESG strategies can significantly vary according to investors preferences.
The most common types fall into three categories (MSCI 2021): integration, value and impact-based (MSCI 2021).
1. Integration
Enhancing returns by including ESG risks and opportunities in long term investment decisions.
Types include:
Bottom-Up Integration: Analysing each investment decision.
Top-Down Integration: Analysing the construction of a portfolio.
Best in Class Integration: Investing according to the best ESG rating in a sector.
Thematic Investing: Investing based on social or environmental trends.
Active Ownership: The investor has a ‘hands on’ approach and actively discusses ESG compliance with companies.
2. Values
Investing according to the moral beliefs of the asset owner.
Types include:
Active Ownership
Best in Class
Exclusionary screening: Actively avoiding some investments due to the company’s values.
Socially Responsible Investing (SRI): Investing according to ethical values (also known as ‘Norms Based Investing’).
Faith-Based Investing: One of the most common forms of ESG investing, this type includes religious values in investment decision making.
3. Impact
Investing to support specified social or environmental causes and enhance returns.
Types:
Impact Investing: Investing with a measurable ESG benefit in mind.
Active Ownership
Mission-Based Investing: Investing to meet philanthropic goals or support the values of an organisation.
Thematic Investing
(Categorisation by MSCI 2021).
ESG credentials were previously measured via the information provided through voluntary disclosures.
However, with the developments in AI capabilities, data can be more thoroughly and objectively considered at scale.
Where is ESG going next?
ESG is undoubtedly on the rise.
This shift is partly due to the changing demographic of investors.
For example, 90% of millennials want to track the environmental footprint of their investments (Morgan Stanley 2019).
The younger generation is increasingly sustainably-minded, preferring investment strategies that deliver financial and environmental returns.
Moreover, investment management industry leaders are centring ESG.
Larry Fink (CEO of BlackRock) described ‘sustainability as (BlackRock’s) new standard for investing’ (BlackRock 2021). He has also repeatedly emphasised the importance of considering ESG related risks to ensure the long term resilience of portfolios.
Overall, ESG is becoming increasingly popular as a central strategy for asset managers. But where will the trend go in 2022 and beyond?
Transparency will likely become more regulated and detailed.
Already, institutional investors can draw on various tools to assess a fund, such as the CFA’s disclosure standards, MSCI’s ESG ratings or PRI’s transparency reporting.
However, the type of transparency investors and regulators expect in the next three years will be more detailed.
In fact, all of the global sustainable finance regulation initiatives expected by 2025 aim to increase ‘transparency’.
This goal means more regular disclosure of quantitative data to regulators and investors (MSCI 2021).
Moreover, of these regulatory initiatives, almost half are expected to be mandatory (MSCI 2021).
Expected mandatory regulations include all three from the EU, including the SFDR (Sustainable Finance Disclosure Regulation), the Taxonomy Article 8 Disclosures Delegated Act and the Corporate Sustainability Reporting Directive (proposed / in consultation).
These enhanced expectations are especially relevant to asset managers, with over 60% of initiatives planned globally before 2025 naming financial entities as holding reporting responsibility (MSCI 2021). Half of these regulations are highly likely to be mandatory.
In short, regulators are likely to demand regular ESG reporting from private companies and financial entities by 2025 at the latest.
ESG is more than considering the carbon footprint.
With the increasing expectations of in-detail, regular ESG reporting, the breadth of ESG credentials is also expanding.
For example, the introduction of the Taskforce on Nature Related Financial Disclosures (TNFD) in 2021 means biodiversity is becoming the next significant ESG consideration.
Natixis even described it as the ‘missing piece in the ESG puzzle’ for institutional investors (Natixis 2021).
The inclusion of nature in ESG strategies was also a central discussion point at COP26.
For example, thirty major institutions signed a financial sector commitment letter stating climate and biodiversity considerations are part of their fiduciary duty.
This group included JGP Asset Managers, East Capital Group, AXA Groups and Fidelity International.
In total, the signatories combined asset value was $8.7 trillion (Race To Zero 2021).
Leading organisations like the PRI (Principles for Responsible Investments) have similarly emphasised the ‘critical’ importance of considering biodiversity as part of a sustainable investment strategy (PRI 2020).
Biodiversity is also becoming a part of ESG regulation
In France, the 2021 introduction of ‘Article 29’ saw the first mandatory disclosure regulation on biodiversity impact.
Moreover, the new biodiversity framework by the Climate Disclosure Standards Board signals that related disclosure standards are likely.
This focus on nature by industry leaders, regulators and asset owners is unsurprising considering that it is ranked in the top three long-term global risks by the WEF (2022).
Overall, biodiversity is crucial for asset managers implementing their ESG strategies in 2022.
Get in touch to learn how NatureAlpha can provide biodiversity impact and risk data at scale.
