The Week: ESG - a generational change for investment managers

If there has been a defining issue for the fund management industry in 2019, it is ESG. Everyone – from regulators to politicians to clients to advisers – is suddenly taking a real interest in whether money is being used for good. 

  • Executive management recognises the importance of ESG, but this hasn’t always filtered down to individual fund managers
  • Performance and regulatory considerations are likely to force ESG integration; while non-ESG integrated firms may find it increasingly difficult to raise assets
  • This is likely to be a generational change for investment managers

Asset managers have been addressing the ESG problem with some urgency, but with mixed results. Square Mile research has found a major gap between executive-level commitment to ESG within fund management companies and the performance of individual funds. In general, management teams are taking action, but this has not necessarily filtered down to fund managers. 

This gap may not ensure for a number of reasons: first is that fund management executive teams may increasingly incorporate ESG targets into remuneration. Square Mile says this is already happening at the margin but may become commonplace as asset management bosses seek to ensure that ESG goals are implemented throughout the organisation. 

There may also be performance considerations. As more companies adopt an ESG framework across their business, there is a question over whether there will be a buyer for ‘bad’ assets in future. While it may be possible to be a tobacco company that is working to improve its environmental and health footprint, a tobacco company that isn’t committed to improving may struggle to attract capital permanently.

Square Mile says that it already sees some buyers without an ESG mandate avoiding certain assets because they know other investors won’t buy them. This becomes self-fulfilling. A fund manager neglecting ESG considerations may see performance weaken as the risk premium demanded by the market to hold toxic assets increases. 

Finally, it may become increasingly difficult for companies without full ESG integration to raise assets. This has already been seen in the institutional market, where regulatory changes on fiduciary obligations make it near-impossible for asset owners to buy into non-ESG mandates.  

For the time being, the drive to ESG in the retail market has been led by clients, but this is likely to change next year as new ESMA rules come into effect. These say that advisers must build sustainability requirements into suitability analysis. This is likely to be a ‘game changer’ says Square Mile. The hype around ESG has not necessarily translated into asset flows, but the group believes this will change in 2020. The asset management industry is on the cusp of a generational change.