Insight

Evolution of ESG investing

Near-term implications and strategies for asset managers

The concept of investing in environmental, social and governance (ESG)-centric products is not new. Institutional investors have long modeled their investment strategies around socially responsible themes such as clean air and water, diversity, human rights and workplace fair practices. However, sustainable investing in its current form has recently experienced considerable market momentum, driving large inflows into ESG focused products, resulting in an average Compounded Annual Growth Rate (CAGR) of 27 percent in global assets under management (AUM) over the last six years.

There’s been a significant jump in AUM for ESG-centric products, particularly in the past two years of the COVID-19 pandemic.

Regions	Growth 2015-2017	Growth 2017-2019	Growth 2019-2021	CAGR 2015-2021
Australasia	14%	14%	31%	9%
Canada	29%	33%	289%	37%
Europe	25%	32%	114%	23%
Middle East & Africa	82%	44%	-16%	14%
South & Central America	60%	30%	154%	32%
USA	24%	44%	135%	27%
Asia ex-Japan	-11%	49%	-15%	2%
Japan	36%	191%	545%	71%

Source: Lipper, a Refinitiv Company, January 2022

We’ve seen a significant inflow into ESG-centric products, particularly ETFs, during the past two years, and we expect that trend to continue and accelerate.

Murali Sreedhar, Managing Director, Advisory, KPMG LLP

Product strategy

Passive and active managers are taking different approaches in terms of providing ESG-friendly investment products. This can range from integrating ESG-focused vehicles into an existing product framework to screening techniques that select suitable ESG offerings to creating new ESG-themed investments.

Bloomberg Intelligence predicts that passive investing will overtake active investing in the U.S., and eventually will do the same in non-U.S. markets (although at a slower pace). We believe this growing demand for passive products will result in an increasing number of passive ESG-based product offerings in the marketplace, especially in the U.S. where mutual funds and exchange traded funds (ETFs) are attracting huge investment flows.

Approach:
Product Strategy

There are many specific or hybrid approaches managers can take towards developing an ESG product strategy. Below are some key strategies being adopted to provide ESG-themed investment offerings:

1. Screening investments for ESG specific characteristics

Negative screening means excluding one category or sector of stocks from a portfolio, for example companies associated with tobacco, alcohol or weapons, or that engage in certain practices like animal testing or coal mining.

Positive screening means including one category or sector of stocks within the portfolio that meet defined scorecard thresholds and exceed industry standards in regard to ESG performance.

Norms-based screening means excluding companies that fail to comply with international standards established by organizations like the Organization for Economic Cooperation and Development (OECD), the United Nations (or one of its sub-agencies, like the International Labor Organization (ILO)) or specified non-governmental organizations (NGOs).

2. Integrating ESG investments into their existing models

While the primary factor in ESG integration is still financial performance, investors take into consideration a company’s ESG activities and “scores” when deciding whether to invest.

3. Investing based on defined sustainability themes

This approach enables investors to invest in specific aspects of ESG. Typically, these would be companies focused on environmental solutions (e.g., clean air or water, sustainable agriculture) or social issues (gender/racial equity, diversity, transgender rights).

4. Impact investing

These are investments intended to accomplish or have the most impact on social or environmental issues, including underserved individuals or communities. To succeed in this approach, you’ll need to be able to measure and report on the impact the investment has on the intended goals.

5. Influencing ESG friendly corporate behavior

Managers are leveraging their shareholder positions to influence corporate behavior to align with their ESG-based agenda. This includes communication with executives, filing shareholder proposals and proxy voting.