Data linking environmental, social and governance values to investment outcomes has seen an industry shift towards considering ESG issues as part of honoring the fiduciary duty, according to State Street Global.
State Street head of ESG investment and asset stewardship Rakhi Kumar and ESG investment strategist Alison Weiner have called attention to five trends emerging in the responsible investing space, based on a past survey they conducted with 300 global institutional investors.
Looking forward, they expect the coming year to see “critical ESG infrastructure built and the further maturing of the ESG market”.
One trend the pair has predicted is that ESG assessment will become a fiduciary duty for investors.
“To be considered as part of fiduciary responsibility, an issue – and the data that describes – [need] to be seen as relevant to investment outcomes,” the State Street report read.
“Because the roots of ESG investing go back to socially responsible investing, a values-based framework, investors often debate if ESG is part of fiduciary responsibility.
“There is growing awareness within investment organisations – backed both by academic evidence and growing ESG teams – that such issues matter to long-term company performance.”
Data from the Sustainability Accounting Standards Board (SASB) is said to have allowed investors to quantify and compare companies’ operational performance on the ESG risks and opportunities that matter most to their industry.
Further, the increased incorporation of ESG into index portfolios is tipped to additionally normalise ESG investing in active strategies.
“This along with the evolving understanding of fiduciary responsibility means that active managers who do not incorporate ESG into their company due diligence and investment processes will need to explain why they don’t see ESG as a portfolio risk or an investment opportunity,” State Street said.
SASB guidelines to become industry standard
Ms Kumar and Ms Weiner have also forecast the Sustainability Accounting Standards Board (SASB) will emerge as the leading global ESG disclosure framework, despite the number of companies reporting against it still being low, at just above 100.
The SASB was established as a nonprofit that sets financial reporting standards in 2011, but in the third quarter of 2019, there was a recorded 150 per cent increase in the number of companies reporting against it year-on-year.
State Street suspects SASB will become the preferred standard for investor sustainability disclosure because it focuses on metrics that are financially material unlike other reporting frameworks.
It added the SASB provides tools that are accessible and easy for users to understand and the standards can play a valuable role in investors’ implementation of their TCFD [Task Force for Climate-related Financial Disclosure] commitments, as a framework for climate metrics reporting.
Further nuance in 2020
State Street has also predicted ESG strategies will become more complex in 2020 – deepening the previous typical process of setting a single ESG objective alongside financial objectives, such as reducing exposure to a particular sector.
The firm has observed investors beginning to set multiple ESG objectives within portfolios, for example, eliminating exposure to a number of sectors while minimising exposure to underperforming companies and setting broad emissions targets across all holdings.
But the added complexity will have implications for both portfolio construction and product development, State Street noted, adding institutional investors, who still seek market-rate returns, will need to be comfortable with more nuanced and potentially more algorithm-oriented methods of building portfolios.
Products are predicted to evolve to evolving goals, to meet more complex demands emerging in the market.
Bringing ESG screening in-house or outsourcing?
With growing awareness in the public sphere, investors will also need to justify their screening processes, whether they implement it themselves or outsource the process to third-party ESG data providers.
State Street has called that as ESG investment products become increasingly scrutinised by regulators and activists, it will become “untenable” for investors to fully outsource their exclusionary screening work – asset managers will need to take greater ownership.
ESG issues are also expected to top boardroom agendas, as directors respond to investors and account for customers, employees, suppliers, communities and shareholders.
“In order for boards to effectively oversee this broader set of issues, companies will need to build up the internal infrastructure needed to effectively manage and disclose them,” State Street said.
“We expect to see companies collecting new types of data, building new reporting mechanisms, and focusing their performance against these financially material issues.”
Sarah Simpkins is a journalist at Momentum Media, reporting primarily on banking, financial services and wealth.
Prior to joining the team in 2018, Sarah worked in trade media and produced stories for a current affairs program on community radio.
You can contact her on [email protected].