By Eric Pedersen, head of responsible investments at Nordea Asset Management
While headlines of sustainability scepticism have recently become more apparent, reports of the death of ESG are greatly exaggerated. In the real world, the undercurrent of responsible investing continues to strengthen, as supporting regulations are continually rolled out around the world.
As we move closer towards the US presidential election later this year, we may see intensified political debate on the ESG acronym. Still, it will not stop the momentum behind sustainability factors from entering the mainstream of investing. The focus now shifts to asset managers, as demands increase to demonstrate the substance and integrity of sustainability-related claims.
Greenwashing fears continue
There have been numerous stories surrounding an apparent investor exodus from ESG strategies over the past year or so, but often these do not tell the full story. While the last quarter of 2023 saw the first outflows from SFDR Article 9 funds – alongside those in Article 8 category – assets in Article 8 and 9 funds actually hit a record high share of European fund assets, at almost 60%. In fact, global fund assets in funds deemed ‘sustainable’ by Morningstar rose from $2.5trn at the end of 2022 to nearly $3trn by the end of last year.
If we look closer at the data from Europe collected by Morningstar, the ESG funds with the largest outflows were Article 8 funds with no commitment to sustainable investments as defined under the SFDR. This could reasonably be related to concerns surrounding greenwashing, as investors take a closer look at the strategies labelled as ESG that offer little differentiation from traditional vehicles with no sustainability lens. This clearly shows that some investors still harbour doubts about the validity of the sustainability-related claims.
Despite such nervousness, surveys among institutional and retail investors continue to confirm the desire for value creation in financial terms to be accompanied by positive environmental and social impact. While it does not mean investors are willing to sacrifice financial returns, it does demonstrate the need for managers to achieve returns within a set of guardrails to meet evolving personal and institutional values.
This preference for ESG guardrails is particularly apparent when investors are asked about company behaviours, with a large majority consistently agreeing that companies should be doing the maximum to reduce negative environmental and social footprints. Even though investors may not care about the name of an investment strategy, what is actually delivered is of utmost importance.
Ongoing regulatory action
Regulation in many jurisdictions will continue to support investor aspirations in terms of sustainability. In the EU, adjustments and clarifications to the current SFDR are currently being published, while regulation governing the naming and content of ESG funds is imminent.
In the UK, the SDR is leading to the introduction of category-specific ESG-related products, which should provide additional clarity and alleviate the confusion and hesitance some investors have felt in taking the step from preferences to portfolio implementation of sustainability-related views. The next iteration of the SFDR is likely bring this closer to the thinking behind SDR. Additionally, regulations to further sustainable finance are continuing to be rolled out in the US, Japan, Singapore, as well as other countries around the globe.
From dialogues with our investors, there is a consistent message – ESG factors are increasing in importance and the focus is shifting from easy solutions to the nitty-gritty of what we call ‘returns with responsibility’. It is not enough for asset managers to make claims of ‘ESG alignment’; there is also a need to have strong baseline ESG content, robust and effective stewardship activities across portfolios, and specialised tools and approaches in areas like climate and DEI.
External certification of ESG-related processes will also become increasingly important. Notably, on the institutional side, even mandates and strategies that are not explicitly ESG-focused now carry specific demands in areas such as stewardship – related to company engagement and voting at AGMs. Similar requirements are also coming to the fore in climate, as the challenge to contribute to real-world decarbonisation intensifies.