Seven Insights on How the Smart Money Is Approaching ESG

ESG (environmental, social, and governance) and sustainable investments will come into focus later this month as asset owners, asset managers, and policy makers from around the world descend on Dubai for the United Nations Climate Change Conference (COP) in late November. This, the 28th edition of the conference, comes at a time when sustainable investing is taking center stage in both investment and political discussions across the globe.

Analysis of data collected from surveys of both institutional investors (public and private pensions, insurers, foundations and endowments, plus sovereign wealth funds) and fund selectors for some of the world’s largest private wealth management platforms reveals seven key trends defining how the smart money is looking at ESG and sustainable investing in 2023.

1) Politicization has had an impact on ESG investing – but it’s not what you think.
Overall, 57% of institutional investors say the politicization of ESG has altered how they invest in the area. But while “politicization” may bring to mind the anti-woke arguments against sustainable investing in the US, institutions in Europe (61%) and Asia (58%) are more likely to say politicization has influenced how they invest than those in North America (52%).¹

	Global	Asia	EMEA	Latin America	North America	UK
The politicization of ESG has altered how my institution invests in the area.1	57%	58%	62%	40%	52%	56%

One key reason may be that the politics and policies in those regions generally encourage, and in some cases require, institutional investors to adopt ESG. Depending on the region, regulations may require asset owners to pursue climate-related goals, while others have set standards for financial transparency. The resulting environment has provided a tailwind for ESG investing.

For example, the EU’s Shareholder Rights Directive requires asset managers and institutional investors to evaluate ESG impacts on their investment and consider ESG factors as part of their due diligence. On the other side of the equation, its set of sustainability-related disclosure regulations for the financial services sector (Sustainable Finance Disclosure Regulation or SFDR) requires greater transparency from financial companies on the degree to which their products consider social and environmental issues.

In Asia, a range of measures are under way: The Singapore Exchange has implemented sustainable reporting requirements for listed companies. Elsewhere, the China Enterprise Reform and Development Society’s (CERDS) Group Standard for ESG Corporate Disclosures is designed to align ESG disclosures with investors’ needs and requirements. Thailand’s Securities and Exchange Commission has made sustainable development strategy part of mandatory reporting requirements for listed countries.

In North America, and particularly in the US, a cursory look at the headlines might suggest a political headwind for ESG. But there are significant regional and philosophic differences in which conservatives reject the ESG as “woke” and more liberal enclaves, like California, embrace the practice.

When it comes down to it, 83% of institutions globally are implementing some form of ESG/sustainable strategy in their portfolios. While the level of adoption is greatest in Europe, Middle East, and Africa (EMEA, 92%), there is still a hefty two-thirds majority of institutions implementing some form of ESG in North America.¹

2) ESG has become an integral part of the investment process.
Where analysis of environmental, social, and governance factors may have once been seen as a distinct process for a specific type of investment, the application is demonstrating broader value. In fact, seven in 10 institutional investors say ESG analysis is integral to sound investing.¹

This analysis is not limited to the downside of identifying risks and/or blocking out exposures to certain companies and industries. More than six out of 10 institutional investors (62%) go so far as to say there is alpha to be found in ESG investing.¹

This more holistic view of analysis and alpha-seeking mindset shows up clearly in the wide range of ways institutions say they implement ESG across their portfolios. Almost half (49%) of those surveyed rely on an integration strategy that allows them to include non-financial factors alongside their fundamental analysis for a more comprehensive consideration of investments.

One-third of institutions also include negative screens designed to weed out investments that do not fit their ESG criteria. However, close to the same number (31%) are turning to a more proactive best-in-class approach that emphasizes companies with better or improving ESG performance relative to sector peers.¹

How institutions are implementing ESG¹

ESG integration	49%
Exclusionary screening	33%
Best-in-class selection	31%
Impact investing	29%
Active ownership	28%
Thematic investing	28%

Almost three in 10 (29%) include impact investments that seek to generate social or environmental benefits alongside financial returns, a strategy more widely implemented in EMEA (35%). Another 28% also apply thematic strategies that focus investments in specific social, industrial, and demographic trends.¹

Fund selectors at large wealth management firms report a similarly diversified approach in their ESG strategies: 46% are using integration strategies. But they are also likely to emphasize best-in-class (36%), thematic (34%), and impact (33%) investments versus more exclusionary screens (31%) in their client offerings.²

3) ESG investments are extending beyond traditional asset classes.
Institutional investors report that their pursuit of ESG and sustainable investments reaches well beyond stocks and bonds, and that their approach is extending to both public and private markets.

Equities (71%) remain the number-one place where the smart money is seeking out ESG opportunities, but a large number also put ESG into focus in the income side of their portfolios, as 41% report they are pursuing ESG goals in their bond holding by investing in instruments like green bonds.¹

The hunt for ESG opportunity also extends to institutional interest in private assets. In fact, 41% of those surveyed say they apply the same standards to identifying private equity opportunities as they do with traditional equities, while 24% are pursuing ESG objectives with investments in private debt.¹

Close to one-third globally (32%) are also putting assets to work in infrastructure which gives them access to wide-ranging investment opportunities from clean water projects to efficient energy grids, to clean energy plants, to mass transit projects. Another 30% are also seeking out opportunities in real estate.¹

4) Individual investors are driving demand for ESG at wealth managers.
Where politics and policy may be key drivers of ESG adoption among institutions, fund selectors report that one of the immutable laws of capitalism is driving adoption among wealth managers – demand.

How great is that demand? A recent survey of 8,550 individual investors in 27 countries conducted by the Natixis Center for investor Insight found that seven in 10 said that if a fund had a better carbon footprint, they would buy it. This high level of demand is the key reason that 87% of fund selectors at leading private wealth managers globally say their firms include ESG investments in their client offering (96% EMEA, 91% UK, 78% North America).²

Fund selectors, who are responsible for evaluating the investments that will be made available on wealth management platforms, have a unique view on the direction of ESG investing in that their firms must constantly work to address what their clients want and why they want it.

In their view, the number-one reason clients ask for ESG and sustainable investments is their desire to address social and environmental problems (43%), a sentiment that is strongest in North America (49%). But there are additional factors driving demand as well.²

In fact, 37% of fund selectors say that investors are beginning to recognize the benefits of integrating analysis of non-financial factors alongside fundamentals, a rationale expressed by 44% of those in Asia, 43% in EMEA, and 42% in the UK. But selectors also report that clients see new opportunities in ESG: Overall, one-third globally and 41% in Europe report that as solar power and electric vehicles become more prevalent, clients are looking for ways to participate in the green economy.²

As a business, wealth managers are also very much aware of the need to adapt to a changing client base. With Millennials coming into view as a business driver for the next 30–40 years, and their known preference for more sustainable investments, 30% of fund selectors say changing client demographics are driving ESG demand, particularly for firms in the UK (37%) and in North America (36%).²

Top five factors driving ESG demand among clients²

Desire to influence social and environmental problems	43%
Investors recognizing the potential benefits of integrating ESG factors alongside financial factors	37%
Desire to participate in the green economy	33%
Changing demographics of client base	30%
Broad-based adoption of ESG across client segments	29%

Overall, the factors most cited in this survey demonstrate that clients are seeing this as a long-term change in investing, especially since just one in five (21%) fund selectors globally and just 12% in Asia report that the recent energy crisis brought on by the war in Ukraine is driving consumer demand for ESG.²

While consumer demand is strong, firms are also conscious that different clients have different needs. Some firms may be feeling pressure from clients who are not believers in ESG. In this case, it appears selectors are working to balance the scales of consumer-driven capitalism, and 44% say they are also actively seeking out managers who are not considered “woke.” This trend is not limited to North America where 46% are conscious of providing the option. Selectors in the UK (46%), EMEA (45%) and Asia (42%), are following suit.²

5) Standardization is making it easier to adopt ESG practices.
For many years, one of the key arguments against ESG investing has been a lack of a common definition and a common measurement of results. Over time, those objections have ebbed as policy makers have come to some agreed standards and practices. As a result, in 2023, 73% of institutions agree that standardization is now making it easier to adopt ESG and sustainable investment practices in portfolios.¹

73% of institutions say standardization makes it easier to adopt ESG practices

Key examples of these measures include the Morningstar Sustainability Ratings for Funds; S&P’s Essential Sustainability Data Intelligence Service, which provides global coverage of individual companies across multiple factors; and the EU’s wide-ranging directives for reporting of non-financial information.

While the data for evaluating investments is growing, institutions are also setting specific standards to their own objectives for sustainability. The largest cohort of institutions are the 50% adopting the United Nations Principles for Responsible Investing (UN PRI). In this, the asset owners adopt six key principles that act in the best long-term interests of beneficiaries, and as fiduciaries, they believe environmental, social, and corporate governance (ESG) issues can affect the performance of investment portfolios.

Another 47% also adhere to the United Nations Sustainable Development Goals (SDGs), 17 goals ranging from clean water and sanitation to renewable energy to good jobs and economic growth. Adoption of SDGs has been particularly strong in Asia, where 57% of institutions apply them to portfolios.¹

As expected, there is a stronger regional bias to regulatory standards. For example, 41% of institutions in North America say they rely on Sustainable Accounting Standards Board (SASB) data for reporting on sustainability issues by publicly traded companies, as 55% of its membership is based in the US. Globally, the number is only 29%.¹

Similarly, one-third of institutions in EMEA say they follow the EU Paris Aligned Benchmarks to analyze environmental performance compared to the standards for emissions set out by the Paris Agreement. And 32% of institutions in the UK focus on the Taskforce on Climate-Related Financial Disclosures (TCFD) for reporting standards.¹

6) DE&I is coming into focus for investors.
Like much of the business world, institutional investors are paying closer attention to Diversity, Equity & Inclusion (DE&I), not just as investors but also as employers. In fact, 72% of institutions report their organization has either implemented or is considering implementing DE&I measures internally. DE&I efforts are growing within their organizations; 47% of those surveyed say their organization has expanded its definition of DE&I in the past year.¹

On the investor side, they are also paying closer attention to DE&I. Close to half (48%) report they are increasingly focusing on DE&I factors among the companies they invest in. Overall, 43% are measuring those DE&I factors, including 56% of those in the UK. In fact, more than one-third (34%) go so far as to say they exclude companies with poor DE&I performance from their portfolios.³

In terms of what kind of impact DE&I has within the companies they are investing with, institutions look at both the rank and file and management within the organization. In probably the strongest indication of how they might see these factors affecting the bottom line, more institutions say they look at board diversity (54%) than look at workforce diversity (47%).¹

7) Institutions recognize they have considerable leverage in the ESG equation.
Institutional investors report a wide range of motivations for implementing ESG. Aligning assets with organization values still ranks at the top of the list, with just under half (48%) reporting that this is driving their actions on ESG, at least in part, and most frequently with institutions in North America (55%).¹

More specifically, four in 10 report ESG efforts are driven in large part by mandates within their organization’s investment policy statement.¹ This could be represented by something as far-reaching as goals for net zero emissions, or something more specific, such as being in agreement with SASB standards or TCFD standards depending on where they are located.

But the third most frequent response is most aligned with their roles as investors – to influence corporate behavior. In fact, 27% of institutional investors say they implement ESG to help meet this investment objective.¹ While it may be tempting for naysayers to suggest that this is all about getting companies to adopt more progressive environmental and social policies, it is important to understand that this motivation may be tied more to the G than the E and the S.

In terms of corporate governance, institutional investors literally have a vested interest in ensuring that the companies in which they invest are transparent about their operations, their accounting, and the risks presented by their business. It’s a role that institutional investors take seriously.

In fact, when asked who should have the greatest influence over corporate behavior, institutional investors start with the government and regulators (55%) who set the laws and rules business must follow. Corporate management and boards (54%) who are responsible for executing business plans and operations within those parameters rank next.¹

Who has the greatest influence over corporate behavior?¹

Governments/regulators	55%
Management/board of directors	54%
Asset managers/asset owners	49%
Consumers	36%
Employees	23%
Retail shareholders	12%
NGOs	7%

Next down on the list, 49% of institutional investors believe the asset owners and asset managers who take a stake in the company have a responsibility to influence corporate behavior to ensure not only that managers are acting in the best interest of shareholders, but that they are avoiding key risks that could diminish stock prices.¹

Further down the line of stakeholders, institutions believe consumers (36%) and employees (23%) share in the responsibility of influencing corporate behavior.¹

Smart money moves
Institutional investors pursuing sustainable investments continue to live up to their smart money reputation. Looking beyond the political and policy debates, they are finding through experience that sustainable investment practices can actually enhance their investment strategy and execution. They are discovering a process that reaches across asset classes as well as public and private markets.

Equally critical in the evolution of sustainable investing are fund selectors who are leveraging many of the same strategies to meet growing client demand for investments that help them meet goals as wide-ranging as addressing social and environmental issues and participating in the green economy.

Going forward, it is likely these two branches of smart money will continue to be the driving force behind the evolution of sustainable investing.