The wealth management industry is continuously changing. As we have seen over the last few years, active management is falling out of fashion and has become less ‘fashionable’ with asset allocators every year this millennium. In the last decade since the global financial crisis, we have seen the relentless expansion of the passive management industry and a consumer base that is more cost-aware than ever before. The king of passive management, Vanguard, is now the largest asset manager in the world and its relentless growth and outperformance of its peers (both in attracting assets under management and in investment returns) continues. The firm has always been the parent of both passive and low cost solutions in asset management and this has had dramatic effects on the industry. As it looks to defray cost pressure, areas of asset management where cost pressures are weaker are of note to the industry.
There is indeed one area of active management that is expanding dramatically, and with less pressure on fees, and this is ethical- or values-led investing. In financial jargon ethical investing is often known as ESG (environmental, social and corporate governance) or SRI (socially responsible investing). ESG has now become the most used term to represent an investment methodology that incorporates risk, return and social outcomes, replacing the previously popular SRI. ESG is predicted to grow at 15% a year for the next few years and how ESG frameworks develop should be of interest to anyone who is concerned about the environment or interested in the investment industry.
What does ESG represent?
- The E in ESG represents the environment, including the externalities, both negative and positive, that an investment decision can create. For example, the energy and waste used by an investment, the resources it needs, and the environmental consequences. Of particular note, environmental criteria include carbon emissions, with reference to likely effects to climate change. Depending on the evaluation methodology, carbon emissions are sometimes considered as negative, in other frameworks the marginal change in carbon usage is more important. Underlying every investment decision, every allocation of capital uses energy and resources, and this in turn affects the world we live in.
- The S represents social factors. The social definition can often be a bit loose, but generally it looks to factors relating to an underlying investment’s impact on society and the broader community. For a firm this could refer to working conditions, health and safety, human rights, diversity and inclusion.
- The G represents corporate governance, and principally relates to oversight and stakeholder management. In a well-run business, stakeholder incentives will align with the business’s success. Governance describes the controls and procedures by which a firm is managed and meet the needs of stakeholders. Often with particular reference to the interests of investors / owners vs the executive class and the broader workforce. All organisations can benefit from strong governance. It is hoped by ESG focused investors that by finding well-run companies you can create better social outcomes as well as enjoying superior returns.
Slowly but surely all the largest investment houses are creating and expanding their ESG teams, and they are doing this hand in hand with regulatory support — with global regulators looking to ‘nudge’ investments into socially superior outcomes and requiring additional detailed reporting to better analyse the environmental consequences of an investment manager’s capital allocation.
Here in Europe the EU has created a legislative programme to make environmental, social and governance (“ESG”) issues more prominent in the regulation of the financial services industry. The EU initiative will apply to all asset managers, even those without an explicit ESG mandate, which ultimately means that all investors will have to consider ESG factors when constructing their portfolios. This is going to require new systems, teams and ideas at investment firms large and small.
The largest active asset manager in the world, BlackRock, looks to be embracing ESG throughout its portfolios, as well as making social concerns a key part of its culture. In a January 2020 statement to investors, Larry Fink, chairman and chief executive of BlackRock, said:
“Our investment conviction is that sustainability- and climate-integrated portfolios can provide better risk-adjusted returns to investors. And with the impact of sustainability on investment returns increasing, we believe that sustainable investing is the strongest foundation for client portfolios going forward.”
We can see that ESG is becoming more and more important. These words are being met with actions. BlackRock tends to both bark and bite, with the result that the firm often ends up dominating fields it enters. The changes represent both a commitment to a different way of investing and a sea change in corporate behaviour. Previously at the firm, semi-autonomous investment teams sought to seek advantage as independent units. This created a culture that was often able to outperform. In the new culture, the majority of asset allocators will have to look to their higher corporate principles before investing. This will require more than a tweaking of spreadsheets but an incorporation of new frameworks in the investment process.
All of the larger asset managers are now seeking to position themselves in ESG investing, after criticism from investors, regulators and politicians that the industry has failed to use its influence to act against corporate misbehaviour and mitigate the effect of consumption on the environment.
The steps being taken at BlackRock:
- Positive: Doubling to more than 100 the number of ethical exchange-traded funds, which are investment funds traded on major stock exchanges.
- Positive: Accumulating assets of over $1tn in ESG-focused funds within the next ten years. A cynic might suggest that this is not as all-encompassing a cultural change as BlackRock are making out as it will still only represent 10% of assets.
- Negative screening: It will also cut companies that derive a quarter or more of their revenues from thermal coal from its actively managed portfolios, as it aims to increase its sustainable assets 10-fold from $90bn today to $1tn within a decade.
Across the industry as a whole, ESG is one area where we can see vacant roles advertised in an industry that is contracting, and anecdotally in the last few years we have seen ESG moving from an interesting niche to a core offering at trade shows, conferences and investment committees.
Now in 2020 developing and expanding ESG teams is a priority for investment funds, pension trusts and corporate investors and throughout the financial services sector. The hope is that investors can lead to better social outcomes without compromising returns. With ethical investment teams screening potential investment assets for human rights abuses, strong workers’ rights, corruption avoidance and pollution mitigation, positive change is possible and can be driven by the oft-derided financial services industry.
- This blog post expresses the views of its author(s), not the position of LSE Business Review or the London School of Economics.
- Feature image by PeterDargatz, under a Pixabay licence
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Dan Tammas-Hastings is managing director and founder of outsourced compliance and regulatory hosting firm RiskSave. After a successful career as a fixed income trader specialising in GBP derivatives at Merrill Lynch and as a hedge fund manager, managing multi-billion £ portfolios across credit and rates, he is now a specialist in risk management and is in charge of strategy and investment at RiskSave. Dan has been awarded both the CFA and FRM charters and is a graduate of LSE and the University of Cambridge.