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Skepticism Aside, Asset Managers Push Forward with ESG Development

ESG Investing

Despite political unrest at the federal and state levels, the asset management industry appears to be largely unswayed by the negative rhetoric surrounding the use of environmental, social and governance (ESG) factors for investing in retirement plans.

Image: Chor Muang/Shutterstock.comThis was found to be largely the case in new reports by Cerulli, ISS Market Intelligence and Cogent Syndicated.

According to Cerulli’s white paper, Global State of ESG, asset owners and managers remain focused on ESG initiatives, despite heightened regulatory scrutiny surrounding “greenwashing” and negative investor perception. Even as firms acknowledge and take measures to quell cynicism, few show signs of being deterred by skeptics or deviating from the courses that have been set, the report notes.  

For instance, fears of negative returns and the perception that performance may be sacrificed in the name of ESG/sustainability continue to be a major challenge to firms when it comes to marketing their strategies. Despite this, Cerulli found that managers are forging ahead with product development, sales, and marketing of ESG products. In the U.S., 58% of managers consider ESG a top product development initiative, while nearly half (49%) of asset managers in Europe consider ESG marketing a “very important feature” of their overall marketing efforts.

Cerulli’s data further shows that both U.S. and international asset managers welcome the opportunity for clarity on so-called greenwashing. The majority of U.S. asset managers polled by Cerulli believe the SEC should be responsible for setting standards around both public companies’ ESG disclosures (73%) and asset managers’ ESG standards and product definitions (58%).

“Overall, Cerulli’s research reflects an industry largely unswayed by negative rhetoric surrounding the topics and concepts related to ESG investment,” says David Fletcher, Associate Director at Cerulli. “By and large, sustainability and the overarching themes of ESG investment are already ingrained in the asset management industry. The challenges firms face in implementing ESG investment initiatives are pain points that will likely be viewed in retrospect as necessary steps in the legitimization and long-term success of these goals,” he adds.

Proceed with Caution

In a similar vein, Cogent Syndicated’s 2023 US Institutional Investor Brandscape suggests that institutional investors appear to be acting with “appropriate caution” yet are continuing to evaluate ESG strategies as complements to their existing portfolio holdings.

Demand is strongest among $1 billion-plus defined contribution (DC) plans and insurance company general accounts. Non-profit institutions, meanwhile, are the most likely to be already integrating ESG investing, while defined benefit (DB) plans report the lowest current use, the report notes.  

DC plans are likely responding to participant demand, particularly from Millennial and Gen X employees. “Demand for ESG is being fueled by younger cohorts who are particularly sensitive to environmental and social factors,” writes Linda York, Senior Vice President at Cogent Syndicated. “These constituents take the form of Millennial DC retirement plan participants and younger investors overseeing institutional assets. Consultants and outsourced chief investment officer firms (OCIOs) are quick to point out that when the 30-somethings get to be CFOs, they’ll bring a different perspective and focus to the investment decision-making process that will be dramatically more ESG-centric,” she further observes.   

When asked about the reasons for adopting ESG investment strategies over the next 12 months, institutional investors for DC plans cited the following:

  • Environmental (74%)
  • Social (69%)
  • Governance (43%)
  • Other reasons (6%)
  • Don’t know (less than 1%)

When asked about the top three barriers to ESG investing, institutional investors for DC plans cited the following:

  • Inconsistent definitions (11%)
  • Fiduciary concerns (18%)
  • Poor investment returns (16%)

“Despite these ongoing concerns, the institutional community appears to be converging on the opinion that ESG investing—particularly the environmental aspect—is here to stay,” adds York. “Many feel that stronger ESG movement outside the U.S. will help keep the ESG movement from stalling completely.”

ESG Product Launches

Meanwhile, ISS Market Intelligence’s report—State of the ESG Fund Market—shows that fund providers are continuing to launch new ESG products at a healthy pace, indicating that asset managers expect demand for ESG-themed investments to remain strong. While new fund launches slowed across most product types in 2022 (including ESG), 89 new ESG strategies went live—short of the record 133 launches in 2021, but well ahead of 2019 and 2020 levels, the firm notes.

Additionally, net flows for U.S. ESG funds, at $3 billion, finished 2022 in positive territory with ESG funds seeing organic growth tick up 0.8%, as long-term fund flows shrunk at a 1.4% pace. At year-end 2022, long-term ESG fund assets under management (AUM) clocked in at $319 billion, accounting for 1.5% of all long-term AUM, ISS MI further notes. That said, the report also observes that, amid turbulent markets, spiking energy prices and political backlash, demand for ESG products slowed in 2022.

Other findings show that ESG index funds outsold active ESG funds by more than a 2-to-1 margin from 2020 to 2022, but active strategies accounted for an increasing share of new product; 75% of ESG funds debuting in 2022 were actively managed and almost half of these were active ETFs.

“While 2022 revealed ESG products as hardly immune to broader pressures, their resilience amid challenging conditions should quell concerns that buyers would bail at the first sign of trouble,” says Christopher Davis, head of U.S. Fund Research at ISS MI and lead author of the report. “Such stability is a welcome sign that ESG funds’ recent market share gains were not merely a short-term phenomenon.”

ISS MI’s report further shows that the number of funds adding prospectus language indicating that they use ESG factors as part of their investment strategies reached record levels last year, as did the volume as measured in terms of AUM. In all, the firm’s analysis finds that funds representing more than $1.9 trillion in assets incorporated ESG elements into their investment process this past year. The lion’s share came in the first quarter when American Funds disclosed it would include ESG factors as part of the investment process firmwide—making it the largest fund manager in the U.S. to do so, according to the report.