There has never been a better time to invest based on environmental, social and governance principles. Institutional asset owners are benefiting from a menu of ESG strategies, products and capabilities that is bigger than ever before. Innovation by asset managers and increased regulatory pressure is driving ESG investing forward.

Most asset owners, 85%, believe that ESG factors are material to investment policy, while 70% say ESG factors have become more material in the last five years, according to the Voice of the Asset Owner survey from Morningstar Indexes and Sustainalytics this year. Yet the survey also revealed that ESG implementation remains a slow process: Only 29% of asset owners said they use ESG factors for more than half their total portfolio.

The biggest concern of asset owners continues to be the bottom line, said Christopher McKnett, co-head of sustainable investing at Allspring Global Investments. “It’s always about performance. From our perspective, given some of the equity market rotation that we’ve seen over the last 12 to 18 months, with value doing better than growth and the strong performance of energy, investors want to know how that affects performance today and what it means for the future,” he said.

But investing for ESG and the energy transition from fossil fuels to a net-zero economy isn’t an and/or proposition, McKnett added, referring to the United Nations-led goal of moving to eliminate greenhouse gas emissions. “We think it’s an ‘and,’ not an ‘or,’ because solving for energy security can often take you toward a more diversified energy mix and, ultimately, away from more potentially volatile fossil fuels.”

Asset owners’ concerns with ESG adoption aren’t limited to performance, though. McKnett pointed to what he calls the authenticity issue. “Our institutional clients are doing deeper diligence on [asset managers] than they ever have before,” he noted. “When I started in the asset management business years ago, it was ‘Tell me what you do.’ Now it’s ‘Tell me and show me, and back it up with examples A, B and C.’

MEETING SPECIFIC TARGETS

Customization is often needed to effectively deliver the ESG integration that plan sponsors seek for their particular portfolio objectives. But often there isn’t enough customization available, according to Gareth Shepherd, portfolio manager at Voya Investment Management and co-head of the Voya Machine Intelligence team.

“In our meetings with asset allocators,” Shepherd said, “we hear a lot of desire to move away from plain-vanilla or look-alike strategies that just mirror the same thing, be it ESG leaders or highly rated ESG companies. Sponsors want to move to a differentiated set of offerings. They’re in a bind because when they look to see what’s available, there isn’t necessarily the customization they need to meet their ESG requirements. This is an unmet source of demand that investment managers need to step up and deliver on.”

His team has built an innovative and flexible quantitative investment approach that uses machine learning, among other artificial intelligence tools, for its ESG-integrated solutions.

NEED FOR CLARITY

Conversations can come back to the basics, where plan sponsors often are not sure about what ESG investing is, said Claudia Wearmouth, managing director and global head of responsible investment at Columbia Threadneedle Investments. “We see a huge amount of confusion about ESG. The onus is on asset managers to be really clear about the strategies they provide and if and how those strategies address ESG. The biggest confusion seems to be around assessing ESG risks and opportunities at a stock level for mainstream strategies that don’t have a specific ESG objective or sustainable mandate. Managers need to be transparent and clear about their investment-research process and active ownership, and what they actually do to take into account material ESG risks and opportunities.”

“Sometimes asset owners who are confused say they want non-ESG funds, which is like saying, ‘I’m not prepared to think about aspects that could represent a material risk to a company,’” Wearmouth pointed out. “Managers need to explain that ESG risks exist even in portfolios that aren’t specifically focused on ESG.”

Columbia Threadneedle offers mainstream strategies that can include sustainable mandates across asset classes, as well as sustainable strategies designed for different objectives of asset owners, she said.

Read More @Pensions&Investments