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Clearing the Deck For ESG Integration

Advisors are running out of excuses to avoid environmental, social and governance investing.

Advisors are rapidly running out of excuses to avoid, environmental, social and governance investing (ESG), though one significant obstacle remains.

A recent survey by State Street, voluminously titled The Investing Enlightenment: How Principle and Pragmatism Can Create Sustainable Value through ESG, casts light on the increasing client demand of ESG investments and financial viability of integrating ESG factors into active investment strategies. It questioned almost 600 institutional investors and 750 individual investors about incorporating ESG factors into investing and business decisions. In doing so, it also identified a single major sticking point preventing widespread acceptance of ESG analytics — “a lack of transparent, standardized and quality data.”

The three most commonly perceived barriers to ESG investing are:

  1. The perception that ESG integration means worse financial returns.
  2. The fiduciary duty of fund managers precludes ESG investment because of the perceived sacrifice of returns.
  3. Investors’ outlooks are too short-term to realize the positive effects of ESG investing. 

According to the survey, these barriers are receding. Only 35 percent of institutional investors surveyed believe that incorporating ESG would sacrifice returns. For individual investors, the numbers were basically identical, with 35 percent being wary of ESG’s effects on returns, and further, only 29 percent considering concerns of underperformance as a barrier to adopting ESG investments.

On the fiduciary front, a measly 10 percent of institutional investors see fiduciary duty as a hurdle to integration. Indeed, 40 percent of asset owners and 51 percent of asset managers believe that the concept of fiduciary duty is actually shifting towards the inclusion of ESG factors, rather than exclusion.

As for investors’ patience, institutional investors are more willing to wait for outperformance than retail investors. 75 percent of institutional investors expected ESG to demonstrate outperformance within three years or more, and 45 percent would be willing to wait five years or more. Retail investors are less indulgent at just 42 percent. That being said, among retail investors, far more consider achieving long-term gains very important or important as compared to 34 percent who value short-term market outperformance. So, underlying investor sentiment appears to be shifting favorably for ESG integration.  

Overall, according to the survey, a whopping 96 percent of institutional investors want companies to explicitly identify ESG factors that materially affect performance and 46 percent of retail investors feel the same.

However, these desires are tempered by general mistrust of the data currently available. 60 percent of surveyed institutional investors cite a lack of industry standards for measuring the impact of ESG factors as a major barrier to their integration. Among retail investors, 46 percent want to see ESG data from sources other than the companies themselves so investors can make more informed decisions. Overall, 80 percent of total respondents believe there is a lack of standards among ESG integration.

Lou Maiuri, executive vice president and head of State Street Global Exchange and Global Markets businesses explains, “The promise of this new type of investing, ESG, is grounded in data transparency and engagement. Having a custodian for data has become just as critical as having a custodian for financial assets when trying to deliver long-term returns for investors.”

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