Has ESG Investing Peaked?

^{[An update to content originally published on September 19, 2022]}

ESG has enjoyed immense popularity as an investment strategy for years, but recent results suggest it’s starting to cool. So, has ESG peaked? The short answer: it’s complicated.

You don’t have to look far to see how environmental, social, and governance (ESG) factors are taking center stage in many of our daily lives.

• Thinking of the ‘E’ in ESG, the global impact of climate change is hard to ignore. According to NASA, July 22, 2024 was Earth’s hottest day on record.¹
• In recent years, the ‘S’ has moved into the spotlight as companies address concerns about employee well-being.
• While the ‘G’ may sometimes feel like an afterthought, governance is often what pushes firms to make bold changes in response to social equity, climate change, and overall stronger corporate governance.

ESG investing in a changing environment

While critics label ESG investing as virtue-signaling and argue that sustainable investing lacks the financial returns to substantiate its value, demand for sustainability-driven investment products and businesses tells a different story.

A survey published by the National Retail Federation shows a majority of US consumers — particularly younger demographics — are willing to pay extra for more sustainable products.² Investment firms are also allocating trillions of dollars to sustainability-aligned investments. Global Sustainable Investment Alliance reported in November 2023 that $30.3 trillion is invested globally in sustainable assets. ³

An October 2023 survey from Capital Group across 25 countries found that 90% of investment professionals had adopted ESG in their investment approach.⁴

Underpinned by new regulatory frameworks and a consumer shift toward sustainability, several factors suggest ESG investing is becoming an essential part of the investment landscape. With that in mind, firms must be prepared to incorporate, analyze, and understand the massive volumes of ESG data in their investment strategy.

Understanding imminent ESG reporting regulations

As investment institutions increasingly factor ESG into their corporate decision-making and investment preferences, firms must be up to date on regulations, aligned on sustainability to returns, and aware of innovations making the implementation of ESG initiatives easier.

Policymakers have set frameworks to help both businesses and investors tackle global sustainability challenges. For instance, the European Union’s Sustainable Finance Disclosure Regulation (SFDR) and increased corporate reporting requirements via the Corporate Sustainability Reporting Directive (CSRD) are already in effect today. Prescriptive recommendations from the Task Force on Climate-Related Financial Disclosures (TFCD) also offer a preview of ESG’s increasing importance in regulatory frameworks. The regulatory momentum and requirements around sustainable investing and reporting demonstrate this is not a fleeting trend.

According to Bloomberg research from 2023, an astonishing 14,500 ESG-labeled funds hold $7 trillion in assets.⁵ Asset managers face the dual challenge of complying with imminent regulatory requirements while contributing to sustainable practices.

Integrating ESG data

Reliable, timely, and relevant data is essential for building ESG-aware investment strategies, measuring performance, and meeting regulatory demands. ESG data integration provides a competitive advantage by identifying risks and opportunities, improving risk-adjusted returns, and aligning investments with stakeholders’ ethical values.

ESG data challenges

Data management solutions are particularly pertinent as managers progressively incorporate ESG criteria into their strategies to enhance returns and meet stakeholder expectations, and private markets investors deploy direct dollars and raise capital for impact funds. Robust practices can empower organizations to navigate regulatory landscapes, foster sustainable practices, and deliver value to stakeholders.

ESG data sources

• Company reports: Publicly available corporate reports, such as annual sustainability reports, are often based on Global Reporting Initiative (GRI) or Sustainability Accounting Standards Board (SASB) frameworks and often provide detail on a company’s ESG performance and initiatives.
• Third-party providers: ESG data vendors offer comprehensive datasets, ratings, and analyses by aggregating data from various sources, assessing ESG performance and assigning scores or rankings to companies. 
• Proprietary research: Many investment managers conduct their own ESG research or engage with specialized research firms, which can involve quantitative assessments, interviews, and investigations.
• Alternative data sources: Alternative data, such as satellite imagery, social media sentiment analyses and supply chain tracking, can offer unique insights and a more holistic view of ESG risks and opportunities.
• Regulatory filings: Publicly traded companies disclose ESG-related information in regulatory filings like Form 10-K or in annual reports.

Incorporating ESG into decision-making

Businesses are increasingly owning up to their responsibility to understand and respond to risks and help build a stronger and sustainable global economy.

Yet as portfolio managers invest today for the proverbial “promising tomorrow”, there remains a lingering challenge of how to incorporate ESG into their decision-making. Many investment firms are already working from siloed, fragmented technology that limits data integration and hinders their ability to insightfully use data in investment decisions. ESG data is no different.

If investment firms want to continue their pursuit of ESG investing — an element that remains vital to their social license — they must be able to demonstrate strong returns while contributing to a more resilient economy.

That starts with effective data management and powerful tools to decode what investments meet ESG criteria and what fall below standards.

Case study: Keeping up with sustainability requirements

Market challenge: Disparate data methodologies and reporting frameworks

Today’s investors expect reporting alignment with standards, such as the SFDR, to compare asset allocation, risk, and performance data across ESG investment products. Many global regulatory bodies now enforce mandatory ESG regulatory reporting requirements, primarily driven by the EU, with the US and APAC closely following suit.

Access to portfolio-level sustainability data, as well as visibility into underlying asset allocation, are standard investor requisites. However, legacy financial systems were not designed to handle ESG data. The sheer complexity of available ESG information can overwhelm firms that lack the necessary capabilities to handle diverse datasets. The relatively new nature of ESG data means that operational processes and governance can be underdeveloped and lead to greater reliance on manual processing and point solutions.

Arcesium’s response: ESG data integration

Cloud-based solutions that readily connect with ESG data providers or offer integrated ESG information, can enable an investment organization to deploy sustainability-driven investment strategies and ease investor reporting and regulatory compliance. Arcesium’s Aquata^TM offers pre-built ESG data integrations, including ESG ratings, as well as granular ratings attributes from various providers. Aquata seamlessly harmonizes diverse ESG data provider methodologies into a cohesive data model to power analytic dashboards, enabling investment professionals to analyze their holdings. Investors can swiftly respond to ESG queries and support regulatory reporting requirements. A unified system designed to manage and govern ESG data ensures the accuracy and completeness of ESG information, while instilling confidence in downstream workflows and insights

Market benefits: A unified solution to enhance investor and regulatory transparency

With sophisticated solutions to marry ESG data with portfolio information, investment managers can develop offerings that align sustainability criteria with client expectations. Superior data management and analytics empower investors to innovate in an ever-evolving ESG reporting landscape.

LEARN MORE: READ THE FULL CASE STUDY

Evaluating ESG performance

Aligning a company’s ESG information with investment data unveils powerful insights into ESG performance and any associated risks. To evaluate ESG performance, firms must be able to ingest and aggregate data into a unified, normalized data model. They also need the right tools to detect data quality problems and to effectively report performance results to stakeholders.

As investment managers respond to new regulatory requirements to disclose their portfolio- and entity-level SFDR scores, they will need access to robust data to report company-level SFDR data and inform calculation of custom ESG scores. Tools that enable firms to track data alongside each of their entities and portfolios will be critical. Dynamic dashboards that support visualization and enable drilldown into portfolio- and entity-level aggregations further help institutions understand returns on their ESG investments.

If that sounds like a lot of moving pieces, Arcesium can help.

We designed our advanced data, operations, and analytics capabilities to enable financial services firms to take command of their investment lifecycle. Arcesium’s Aquata capabilities offer a seamless workflow that ingests, models, and integrates ESG data, and generates analytics and reporting. Our unified data platform’s inherent, out-of-the-box awareness spans asset classes, lifecycle events, and geographies to help modernize and scale operations, accelerate analytics and reporting, and deliver in-depth business insights.

Understanding the path forward

Investor demand and maturing regulatory frameworks are significant drivers behind the persistent interest in sustainability. But disparate ESG data methodology and reporting frameworks can hinder even the most disciplined and rigorous approaches to evaluating non-financial performance.

Making sense of ESG regulatory reporting requirements is no easy feat.

Our whitepaper, ESG Insights for Future-Ready Asset Managers, delves into the evolution of ESG regulatory reporting, exploring investment managers’ challenges and emerging requirements shaping the industry.

Sources

^{1 NASA Data Shows July 22 Was Earth’s Hottest Day on Record, National Aeronautics and Space Administration (NASA), July 29, 2024}

^{2 ESG Globally Study 2023, Capital Group, October 2023}

^{3 Global Sustainable Investment Review finds US$30 trillion invested in sustainable assets, Global Sustainable Investment Alliance, November 29, 2023}

^{4 Consumers care about sustainability – but will they pay more?, National Retail Federation, April 10, 2023}

^{5 ESG funds: What makes for good performance?, Bloomberg, August 08, 2023}