Effective environmental, social and governance (ESG) investing requires a balance between accomplishing the mission and achieving the required returns. This means making decisions that are part art, part science.
Strong ESG performance during the pandemic led to trillions of dollars in inflows. This drove the underlying philosophy and universe of ESG-labeled products and has led to previously unthinkable predictions of $30 trillion in ESG assets by 2030. Statistical barriers are already being broken. In 2021, for example, banks made more money from issuing and lending green energy bonds for the first time than from traditional debt tied to fossil fuels.
However, as the focus has intensified, the ESG conversation has shifted to more existential questions, including whether there is an “ESG mirage.” Some skeptics have begun to ask “where ESG?” But proponents maintain that ESG benchmarks, products and strategies must be viewed in the context of broader investment objectives and market constraints. Shades of gray are inevitable, they claim, and are not a cover for simple greenwashing.
These debates are important, but for many, the ESG horse is already out of the barn. Today, the task is to determine how to engage and revive the original spirit and drive of ESG as a vehicle for managing and transforming investment portfolios. So which approaches actually work?
For those looking for wisdom rather than noise, it’s worth exploring what some of the world’s least vocal but most sophisticated investors (insurers) are saying and doing around ESG.
Insurance companies take a strategic and long-term approach to their investment decisions, a perspective that also characterizes some of the best ESG programs. Insurers have been dealing with the analysis and underwriting of ESG components for decades, even centuries. They assess exposure to natural disasters and social and political transitions, as well as the continuity and composition of the company’s leadership. Insurers in Europe and Asia have already made significant progress in transferring these considerations from actuarial risk analysis to their balance sheets. As the spring of 2022 begins, more and more US-based insurers are following suit.
New tools, new thoughts
Earlier this year, Conning released its survey of nearly 300 decision makers at insurance companies in the United States to understand how committed they are to ESG investment principles. While the vast majority are committed to these principles, 41% only started implementing their ESG programs in the last year. As a result, insurers need new tools to measure impact and new, longer lenses to view the associated risks and opportunities. They want to incorporate ESG through strategic asset allocation, investment guidelines and risk management practices, the same principles and methods that also support and inform traditional investment objectives and performance.
This careful calibration is one of the reasons why off-the-shelf ESG solutions pose a problem and why it’s important to take a tailored approach. Consider the asset classes that often make up insurers’ portfolios. Combining ESG considerations, particularly the quantification of downside risk with the pursuit of yield and the need for sufficient liquidity, remains a significant challenge. Accordingly, many survey participants highlighted implementation costs and preparation for future standards and initiatives as crucial concerns. In fact, respondents ranked them more important than the potential effect of ESG on overall performance.
This dynamic develops when ESG integration takes place in a multi-asset context. The new ESG-linked bonds and other fixed income instruments offer an interesting opportunity, but demand a closer examination of their purpose and underlying mechanics. In energy, for example, investors may prefer a bias based on their conviction and philosophy on specific ESG elements. This may mean balancing priorities such as economic development and climate change differently. This can bring specific ESG elements into conflict. Intentionality requires a tailored asset selection, rather than a simple selection, to achieve the right balance.
Like most investment factors, ESG principles must also be dynamic and sensitive to the changing landscape. Our survey found that corporate reputation, not regulatory compliance, is the main driver of insurance companies’ ESG engagement. This may come as a surprise amid new rules on wraps and ESG reporting. But financial and insurance regulation in the United States tends to focus on the financial risks associated with climate change rather than the broader social and governance aspects of ESG investments. They are often outside the regulatory scope. This distinction may help explain why regulation is not the main concern.
US insurers have long taken a market-driven approach. Its ESG mindset focuses on opportunity and participation. Smaller companies may see the potential to take on influential roles, while more established players may struggle to keep pace. Conning’s survey shows this dynamic at work. The growing importance of data standardization and industry-agreed targets, such as the Task Force on Climate-Related Financial Disclosure (TCFD), have created new incentives to commit to ESG principles.
Just as crucial, for insurers and all companies, is the lived experience of their teams and key audiences and the relationship between that stakeholder experience and how they invest in ESG. It’s no coincidence that social impact investing has gained more prominence in 2021. Insurers are realizing that for ESG programs to be authentic, they must be empathetic and responsive, again feeding emerging priorities in investment programs . As new tools and solutions are developed, programs must be flexible enough to incorporate them quickly.
The novel no longer
Last year was pivotal for ESG, and as capital continues to flow into ESG assets in 2022, investors of all stripes can learn from the perspective and experience of insurance companies . Amid record growth and increased ESG stock picking and greenwashing communications, we must remember that the best ESG applications take a long and strategic view: They are methodical in their engagement, nimble in their decision-making, open in its vision and deployment and transparent in its involvement. its construction.
Change is difficult, and effectively integrating ESG principles into the investment process will require ongoing effort and persistence. New models and data, better products and partners, and yes, even a little healthy skepticism, all play a vital role in sustaining progress as this journey evolves and endures.
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All posts are the opinion of the author. Therefore, they should not be construed as investment advice, nor do the views expressed necessarily reflect the views of the CFA Institute or the author’s employer.
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