As recently as 5 years ago, ESG (Environmental Social Governance) investing was still considered a very niche activity, and typically, most institutional asset managers that had ESG funds, also known as SRI (Socially Responsible Investing) funds, were managed separately from the mainstream portfolios.
The most striking development over the last 1 – 2 years is that we are seeing more and more institutional fund managers adopt ESG reporting. Private Capital as well as Public Equity funds, are starting to integrate ESG scoring into the analysis of their portfolios. The tendency is that ESG due diligence is not only being integrated to the dedicated ESG or SRI portfolios, but across the whole asset base under management.
The impact of the COVID-19 pandemic
The COVID-19 crisis has brought ESG factors to the forefront of every aspect of our lives. Different to the financial crash in 2008, the recent pandemic has had impacts far wider than the financial sector. Financial institutions are now, more than ever, likely to increasingly consider climate-related, biodiversity and other nature-based risks and opportunities into investment decisions.
COVID-19 has put a spotlight on long-term resilience in portfolios and highlighted the importance of robust risk management processes. It appears that the pandemic, and the global response to it, has accelerated the speed at which ESG reporting is becoming mainstream in investing. Not only are we seeing continued and a more rapid inflow funds into ESG strategies as opposed to mainstream strategies, but the performance of ESG funds, since the pandemic struck, has undoubtedly been better than the mainstream funds.
Research from J.P. Morgan Global Equity shows the cumulative monthly flows for all equity funds, compared to ESG funds before and during the pandemic hit in the following graph.
“Looking specifically at equity, the current trend is impressive, as inflows to ESG products have been growing steadily since 2016, offering a stark contrast with the overall outflows in the industry. The inflows in ESG products are increasing with the launch of new funds as well as the repurposing of non-ESG funds.” 
Interview with Darren Johnson (COO – Listed Equities, IMPAX Asset Management) by Alejandra Alonso (Consultant, Greenstone)
Why do you think considering ESG factors will improve the financial performance of investments over time and especially during a crisis like this one?
“Impax believes the economy is in transition to a sustainable economic model where economic growth is coupled with improved social and environmental outcomes. Impax invests to maximise risk-adjusted financial returns and we believe that we can deliver competitive financial returns by addressing the world’s most pressing sustainability challenges, particularly climate change, environmental pollution, natural resource constraints, demographic and human capital issues such as diversity, inclusion and gender equity.
These trends will drive growth for well-positioned companies and create risks for those unable or unwilling to adapt. We invest in companies and assets that are well positioned to benefit from this transition to a more sustainable global economy. Fundamental analysis which incorporates long-term risks, including environmental, social and governance (ESG) factors, enhances investment decisions. In-depth ESG analysis integrated in the investment processes informs Impax’s knowledge of investee companies’ character and quality. After all, research shows that an ever-increasing and very significant part of company value is from intangibles.
ESG can provide a window into this intangible value and can serve as a “canary in the coalmine”, for early identification of problems in companies, especially in combination with financial or strategic changes. With regards to the connection between financial resilience and ESG, we find that the things that make companies more sustainable tend to also make them more resilient and companies that are more resilient are better positioned to weather the inevitable future crises and downturns and bounce back quickly from them.”
Do you think climate related risk disclosure will become an even more universal issue? How so?
‘Impax views climate change and carbon emissions as a systematic risk for all companies. Impax is proud to be an early signatory in support of the Task Force on Climate-related Financial Disclosures (TCFD). We believe the rollout of the TCFD’s recommendations represents an important milestone in the international financial system’s internalisation of the emerging systemic risks of climate change and welcome the Task Force’s ambition to bring consistency and transparency to climate risk related disclosures.
Companies’ climate related reporting enables investors to assess the climate risk exposure of their investment portfolios and contributes to making informed investment decisions aligned with their fiduciary duties. As the realities of climate change become more and more apparent, policy response is expected to only accelerate in the coming years, with public disclosure on climate risks likely to become increasingly mandatory.’
Global action and long-term solutions
It is clear that the impact of the pandemic will focus investors’ attention on the attractions of ESG investing. However, addressing the COVID -19 pandemic is going to require global action and long term solutions can only be found through innovation and cooperation, and of course finance.
An increasing number of asset managers view the integration of ESG factors as crucial to the financial performance of their investments. The COVID-19 pandemic has brought attention to an opportunity to align investor´s values with their investments. Mainstreaming climate action into regular decision-making is needed now more than ever.
In relation to this topic, read Greenstone's previous blog on Why investors are seeking ESG software to manage portfolio data.