Introduction
There are new global risks in the capital market that are impacting traditional investment approaches and investment managers’ decision-making capabilities. While extreme weather changes like floods and wildfires are becoming frequent, privacy, data security and regulatory pressures are accelerating new risks for investors. Investor perception towards investment has changed; they are increasingly thinking about methods to avoid investments that are harmful to the environment or contribute to societal problems; instead they are focusing on investments that are beneficial for all the members of investment stakeholder community.
Investors are becoming more and more conscious about non-financial factors such as -Environmental, Social, and Governance (ESG) as part of their investment analysis process. ESG factors are starting to play a significant role in identifying m aterial risks, long-term investment and growth opportunities. The below picture represents the different criteria affiliated with ESG.
Trends in ESG investing
- According to Celent ESG assets are expected to grow around $53 trillion by 2022 from $40.5 trillion in 2020
- New generation of investors millennials will direct up to $20 trillion into US ESG investments
- The market for ESG data could reach $1 billion by 2021 as per Opimas research report
- Biggest buyers of ESG data are set managers- 59%, sell-side institutions -19%, asset owners -12%, consulting firms and investment advisers - 6%, and corporates - 4%
- ESG data spending in response to regulatory pressure in Europe is 60%, followed by 33% in North America and 7% in Asia
- European asset managers will be required to accommodate ESG considerations as part of their
- fiduciary duties by 2021
Essentials of ESG investing
ESG investing is accelerating demand across the investment management landscape. Several key trends ranging from the climate, the pandemic situation, and social unrest are gaining momentum, thus substantiating the need for ESG investing.
- Climate changes: Investors are keen on investing in companies that are solving the climate crisis, leveraging innovative technology and propelling humankind’s lead towards the carbon-free economy
- Capital investment in sustainable projects: Banks are stepping away from financing controversial business activities, such as - weapons productions, tobacco products producers, unconventional oil and gas productions, etc., whereas investors/asset managers/private equity investments are showing interest in channeling their capital towards green projects. These ESG changes are ensuring that CFOs of companies are inculcating ESG criteria in their reports to gain the attention of financiers, corporate borrowers, and investors
- Treating sustainability risk in risk management: Risks related to legal, economics, capital and credit have a large impact on the business performance of a company, e specially with respect to profit making. Similarly, ESG risks emanating from environmental disasters, data protection, cybersecurity and ethical standards will have a greater impact
- Engagement & transparency in investments – Investment firms should actively get involved with companies/issuers and collate their ESG risk strategies. Firms can also identify ESG risks and propose opportunities to their board of directors by voting for ESG related decisions. The new generation of millennial investors are also calling for greater transparency in investments
Guiding principle for ESG investments
UN’s (United Nations) PRI (Principles for Responsible Investment) is the leading proponent of sustainable investments across the world. They encourage asset managers to consider environmental, social, and corporate governance facts and data sets in their investment and portfolio management.
Signatories’ commitment
PRI has over 2300 participating financial institutions and they adhere to PRI’s six key principles. PRI defines sustainable investment as the primary strategy for asset managers and urges them to consider ESG factors in investment decision-making. The key factors of sustainable investment are:
- Asset managers should consider the ESG factors while building Investment portfolios that yield good returns for investors in the long term
- Performance of investment portfolios, such as - issuers, equities, fixed income, sectors, regions can be impacted by ESG issues
- Applying 6 PRI principles in their investment decisions
- The investor can encourage companies to improve ESG risks
PRI defines responsible investment strategies for asset managers on climate changes and investment asset classes like listed equity, fixed income, private equity and real estate. Below are snapshots of investment strategies under various asset classes
Mindtree’s SMEs from the capital market Center of Excellence (CoE) have thoroughly analyzed and understood the six PRI principles and help buy-side firms in defining the sustainable business rules in ESG integration and investment strategies.
