A new report on global ESG trends signals that US funds who lead on disclosures may find themselves ahead of the pack.
With all the hype around impact investing and Environmental, Social, and Governance (ESG) criteria, it can be tough to know how much of this attention is warranted and how much is just talk. A new report from Deloitte aims to tackle where ESG trends appear to be headed and what fund managers can learn from those trends.
Titled, “Ingraining sustainability in the next era of ESG investing,” the report covers many topics, including how ESG criteria differ in Europe and the US and how walking the walk on ESG can build camaraderie among employees while bolstering a firm’s authenticity. Some of the most revealing information relates to how quickly ESG criteria are becoming commonplace and how funds can set themselves apart.
The rapid growth of ESG worldwide
As the report notes, while ESG used to be thought of as a niche, “considerations of ESG metrics in investing is now standard practice.” Globally, management firms are responding to investor interest “by rebranding existing funds and by launching new ones that target specific sustainability objectives.”
According to Deloitte, at their current growth rate, ESG assets “are on track to represent half of all professionally managed assets globally by 2024.” Many believe that rather than being a subset of investment products, ESG will become required criteria across all sectors. If that occurs, simply being labeled an ESG fund won’t be good enough to attract capital from conscious investors.
“ESG incorporation may no longer be a differentiator for investors, but rather a standard input for consideration in the investment decision-making process,” the report says. But if we reach a point where half of all funds are considered ESG-focused, something may be wrong with the criteria we’re using.
“We don’t want reporting requirements that are so loose that abuses can occur; at the same time, we don’t want requirements that are so complicated, the reporting burden on investment managers is too great,” offers JTC’s Reid Thomas. “The goal is to highlight those who are doing really great things, and report on that in a way that is meaningful to investors without changing the investment economics.”
With an increasing number of funds boasting of ESG incorporation, you’ll have to do more to stand out than simply telling investors that you’re taking sustainability into consideration. You need to prove that you’re following through, and cater to investors’ desire for both competitive returns and measurable impact.
Transparency as a differentiator
The rapid increase in the number of funds labeling themselves as ESG-focused is why some think ESG criteria are too broad to be useful. “US retail and institutional investors have a sufficient supply of general ESG funds from which to choose, and it may be more difficult for new general ESG funds to gain traction,” says the Deloitte report. Funds may have a better chance of success if they’re hyper-focused on certain aspects of ESG rather than having a general focus, and managers must decide which components of ESG to value most in their investment decisions.
This is especially true in the US, which lags behind Europe when it comes to required disclosures for ESG criteria. It’s up to individual funds to determine where their focus should be and how to communicate that focus. Failure to take a strong stance on which ESG factors to consider and how to evaluate them could make an offering seem weaker. As the report says, “Firms slow to react allow others to make the decision for them as clients could move their assets into a product which they deem more suitable and credible.”
That credibility is key. Investors will have no trouble finding products that fall under the heading of ESG, so the way to differentiate your fund will be through greater transparency and broader disclosures regarding sustainability and other factors. According to Deloitte, this is already happening: “Many investors are seeking greater detail about firms’ holistic incorporation of ESG practices.”
The funds that stand out will be those who not only have a specific ESG focus, but can set measurable goals. Quantifiable impact will be important, as will “regular disclosures about the firm’s progress.”
Preparing for compliance issues of the future
While most of the Deloitte report covers the global ESG market, there are specific lessons for US managers. Europe is well ahead of the US when it comes to ESG disclosures, and so looking at how the EU has handled these disclosures could be a signal toward what we’re likely to see in the US in the future.
As the report says, in the EU, “even funds that lack ESG characteristics or objectives” are required “to disclose how sustainability risks are considered in the investment decision-making process.” These types of disclosures for non-ESG funds may be on the way in the US, as the SEC has proposed broad disclosure rules pertaining to climate-related risks.
While there is great trepidation surrounding how the SEC’s proposed rules will affect fund performance, comprehensive regulation could be a solution to the problem of ESG glut. If every fund is required to disclose climate data, we’ll have a much better basis on which to judge what should actually constitute meaningful action. And though increased reporting burdens can be detrimental, they’ll potentially help those ESG funds doing meaningful work to get noticed.
Standing out in a crowded marketplace is hard when there’s so much political back-and-forth about whether ESG investments are actually making an impact. One example in the US is Opportunity Zones, which help attract investment capital to underserved communities through tax incentives. The program has attracted a great deal of activity, but currently lacks any requirement to report on impact. The results is that the general public not only doesn’t know which OZ funds have had the greatest impact, but whether the program has been effective overall.
“Opportunity Zone investments intended to revitalize communities in need often fail to get the recognition they deserve because of the politics of ESG in general,” says Thomas. “Yet plenty of good work is being done, and reporting requirements can help us cut through the rhetoric and focus on the success these investments are having.”
It’s to be expected that reporting standards and ESG criteria are bound to become more restrictive in the future. Managers who exceed current disclosure requirements will be setting themselves up for success with the compliance challenges of tomorrow. Investors are also expecting more of funds in ways not currently required by the government.
“Some clients nonetheless are asking for greater transparency concerning sustainability risks and factors,” says Deloitte. “A clearly defined fund strategy concerning sustainability risks and sustainability outcomes may reduce scrutiny from regulators and better inform clients.”
How to deliver the ESG information investors want
While stakeholders want information about the societal impacts of investment products in addition to financial metrics, not all fund managers have the experience or capability to deliver them. As the Deloitte report notes, “In order to provide the data needed to perform this type of assessment, investment management firms may benefit from verification or assurance by an independent third party.”
JTC is an industry leader in impact and ESG, and was awarded the Fund Administration: ESG award among service providers at the 2021 Drawdown Awards. We provide a broad spectrum of ESG services for funds, including our virtual Chief Sustainability Officer platform, which can perform many of the functions of an in-house CSO by taking advantage of our industry-leading technology. JTC Americas has also pioneered methods for measuring social impact, allowing managers to demonstrate quantifiable results to investors.
By working with JTC, you can take advantage of our team’s experience in all aspects of ESG to provide regulators and investors with the information they desire, including quantifiable measurement of the effects your investment products have. The way to stand out in the ESG marketplace of the future is to do more than what is required, and by choosing JTC, you’re showing your investors you’re committed to best practices and making a real impact.
Learn more about JTC Americas’ solutions for impact/ESG, by downloading out Impact-ESG Solution Sheet.