What hinders ESG integration

Most institutional investors have realised that ESG criteria drive risks and returns and integrated them into their investment process. However, three problems seem prominent in integrating ESG integration.

A study pursued at the Harvard Business School shows: Companies performing well on material ESG issues have superior returns that low performing firms. Companies that perform high for material and low for immaterial ESG issues achieve average returns of six percent. While companies that perform high on material and immaterial ESG aspects achieve only an average performance of two percent, companies performing low on both criteria sets lose on average 2.9 percent. Identifying material ESG issues and analysing companies according to them should thus be a prime concern for asset managers. 

In fact, integrating sustainabily into investing has a been a trend in the asset management industry. The UN-backed Principles for Responsible Investing (PRI) was signed by 1,500 investors and asset managers, representing about $60 trillion in assets under management. However less than one percent of the total capital of the 15 largest public pension funds is allocated to ESG-specific strategies. Overall, many investors pursue sustainability analysis on the side rather than a core part of their investment process.

The asset management industry clearly understood the value of sustainable investing but seems to have problems in its implementation. In their report “Sustaining sustainability: What institutional investors should do next on ESG” McKinsey identifies three problems:

First, investors need to identify which aspects are material and have strong effect on financial performance. For each industry or even each company, material ESG effects have to be analysed. Thereby, the materiality framework of the Sustainability Accounting Standards Board (SASB) can provide a guideline for analysis.

Second, asset managers need to eliminate greenwashing pursued by companies to look sustainable and hold managers accountable for their claims. With the marketing terms still being part of the screening and analysis process, material aspects of analysed companies are not considered appropriately.

Finally, asset managers question whether selecting on an ESG basis is part of their fiduciary duty. Thereby, regulation regarding the disclose of ESG information is increasing. In France, investors have to measure their portfolio’s exposure to carbon while in the United States, the revised Employee Retirement Income Securities Act obliges managers to choose the more sustainable investment among two financially equal ones. With increasing regulation, managers should soon incorporate ESG criteria further into their investment processes.