McLean Partnership

ESG & Sustainability: The future of finance?

September 30, 2020

At McLean, we have seen an increased demand from clients to recruit for sustainable/ESG investing and advisory roles. What is driving this change? How have investors adapted? And is it here to stay?

Background

In 2006 at the New York Stock Exchange, the Principles for Responsible Investment (PRI) were launched. The UN-created principles were founded on the belief that an economically sustainable global financial system is a necessity for long-term value creation. Such a system will reward long-term, responsible investment and benefit the environment and society. The uptake of these principles by some of the World’s largest institutional investors has been remarkable; signatories have grown from 100 to 3000. To further this commitment to responsible investment, in 2016 the UN launched the Sustainable Development Goals (SDG’s) which have been adopted by all UN member states (193 nations). These goals are more specific than the PRI and cover 17 topic areas, which among other issues include: poverty, inequality, hunger, education, gender, innovation/infrastructure, and water. The fundamental target set out by the SDG’s is a universal call to action to end poverty, protect the planet and ensure that all people enjoy peace and prosperity by 2030.

How have financial services adopted sustainability?

Investment Banks, Private Equity Funds, and Investment Managers are quickly integrating sustainable practices into their investment ideologies and product offerings. Having Sustainable/ESG compatible funds is not just beneficial in terms of the outcomes they are seeking to achieve but also their commerciality for investment firms adopting them. Now that more time has passed, evidence shows sustainable focused investment funds can match or outperform their non-sustainable counterparts. This is aided by a low oil price market and generational step changes to promote greater wellbeing. Conventional funds would often require a three to five-year track record before assets would rise; with sustainable funds, this is happening far quicker with some climate transition funds reaching €2b AuM by the end of their first year. This is further exemplified by ESG-themed ETF’s topping $100bn in total assets for the first time in July (FT:2020).

Where is the demand coming from?

A question we often ask at McLean is: where is the money flowing from, both investor type and geography? The answer is European institutional investors are leading the way, followed by Asia Pacific,  whilst the far larger U.S market lags behind (both retail and institutional), although there are regional disparities in the US with the West Coast more advanced. In the US, this is partly due to a slower investor appetite for sustainable specific fund strategies as many feel having ESG incorporated into investment ideologies is sufficient. Also, the current political resistance to advancing sustainable priorities, and the U.S dependency on oil and gas. On the other hand, in Europe, the regulatory pressure on the principles outlined by the PRI and SDG’s is growing stronger. From new rules on reporting data and integrating it into investment decisions to required disclosure of ESG risk analysis (FT:2020).

Asset Management leading the charge

A quantitative breakdown of financial services serves up a stark reminder in disparity: 65% of the asset managers in Europe are now operating on PRI/ESG principles, expected to grow to 85% over the next five years (FT 2019). However, both private equity houses and investment banks, whilst trying to adopt sustainable best practice, are well behind the asset management industry. A recent report criticised that just 40% of private equity funds incorporated any of the principles outlined by the PRI, and that Investment Banks should do more in their advisory capacity to corporates to help them adjust and prepare, thus avoiding a backlash from investors (Raconteur 2020). Although slow to take up the baton, both are moving towards increased sustainable investment; for example, KKR and TPG recently launched global impact funds and Barclays has significantly bolstered management dedicated to leading ESG initiatives.

Shortcomings

There is however deep-rooted concern that many financial services firms are ‘green-washing’, or they simply don’t have the analytical capability in-house to deep dive and identify whether companies are as compliant as they seem on the surface. Alongside this are external ESG company metrics missing obvious red flags. This was particularly apparent when BooHoo was given an ‘exceptional’ rating and placed in the top 15% of its peers based on ESG metrics, but weeks later the Sunday Times revealed poor working conditions in its factory in Leicester and workers being paid far below the minimum wage (FT 2020). The timely introduction of a new concise ESG investment framework introduced by the big four accounting firms, if successful, could be the first co-ordinated approach to ESG reporting. However, for the time being, the issue around Sustainable/ESG compatible funds seems to be transparency: limited portfolio disclosure, high-level ESG metrics, and different funds aligning with different sustainability goals, all make it hard for investors to see the wood from the trees.

Reasons to be cheerful

There is no doubt that sustainable investing is here to stay and has entered the mainstream. Over the last 2-3 years the product bench has dramatically shifted towards Sustainable/Impact funds. Given the infancy of this market, these funds have seen significant asset flows in shorter timeframes for investment managers, but more pertinently, have had greater impact in terms of tackling the UN’s Sustainable Development Goals. ESG analysis is getting wiser and more specialist teams are being created to improve corporate engagement in relation to SDG’s. The current pandemic has heightened the need for more progressive change and it is pleasing to see sustainable asset growth continue when markets are disrupted. Long may it continue.

At the McLean Partnership we have an extensive track record placing sustainable and ESG professionals across Asset Management, Investment Banking and Private Equity. To find out more please visit https://mcleanimpact.com/ or, for a confidential discussion, please contact paulyoung@mcleanpartnership.com.

Authors: Paul Young and Henry Agnew