By Karoline Thorslund-Andersen

• Published 22/09/21 - MandateWire

The Covid-19 crisis has accelerated the adoption of responsible investment practices as institutional investors have prioritised sustainability in their investment decision-making and portfolio construction. Karoline Thorslund-Andersen, senior consultant at Kirstein, outlines six sustainable investment developments that will impact asset managers’ business prospects in Europe.

While the pandemic has highlighted the importance of sustainability, asset owners’ environmental, social and governance requirements are constantly changing.

ESG measures considered forward-looking and thought-provoking five years ago are now perceived as hygiene factors for most investors.

To help asset managers succeed in the evolving ESG landscape, we highlight six key themes that we expect will shape European investors’ sustainability efforts in the future.

Active ownership 

That asset managers can take an active ownership role and engage within an impact project is vital, particularly for smaller investors.

In the past, the first step towards responsible investment for many investors was to focus on ESG risks and use negative screening to eliminate companies from a portfolio.

However, exclusion of companies with poor ESG characteristics now tends to be the last resort as investors expect active ownership to improve the ESG qualities of exposed companies and to create alpha.

Active ownership requirements for asset managers will increase in the future.

Many investors will seek to understand how asset managers vote; in-house, with partners or outsourcing to a third-party provider, and how often they have voted against management.

They will also scrutinise managers’ engagement activities with companies and expect evidence that shows the impact of engagement. This includes potential improvements in companies’ financial and non-financial performance.

For this reason, we believe that calls for transparency on engagement initiatives and their results will only intensify.

Impact strategies

At present, asset managers who showcase their expertise on sustainability by creating dedicated ESG and impact investment strategies are often rewarded. However, we suspect this may be an interim measure.

ESG factors and the UN’s sustainable development goals are likely to be completely integrated in all investment strategies (with different permutations) in the future.

Storytelling

One softer element of asset managers’ ESG offerings may be their ability to create sellable stories around different impact investments.

Pension funds are increasingly launching sustainable versions of their pension strategies in response to the strong interest in sustainability among pension fund stakeholders.

For example, all commercial life insurance companies in Denmark have a sustainable version of their pension offerings, and large providers in other Nordic countries are contemplating similar initiatives.

Asset managers must understand that a growing number of institutional investors need to communicate their responsible investment efforts to their stakeholders.

This means asset managers must deliver reporting and dedicated sustainable investment strategies to support this message.

Standardisation

Our research confirms that while sustainability is a growing priority, data and information will be more standardised and available to investors in the future.

Asset managers will be expected to have access to all relevant data and have established proprietary ESG models and systems in place.

Measuring and reporting

We also expect investors to increasingly demand that asset managers measure and report on everything from carbon emissions to gender diversity.

Managers cannot blindly rely on external data, but they must develop internal tools and models to validate third-party data. Some local European banks have already developed and implemented such internal models.

Many institutional investors will also ask asset managers to assist them in looking at ESG and impact investing more holistically in the portfolio construction.

With that in mind, we believe the EU taxonomy for sustainable activities will work as a common language for ESG and impact investing.

Alpha generation

Academia and investor communities have come to recognise that ESG investing and alpha creation are not mutually exclusive.

In the new world of ESG and impact investing, investors expect asset managers to take ESG integration to a new level. Instead of only reducing risk, managers must use their knowledge and understanding of ESG dynamics to create alpha.

European investors want asset managers to explain and, more importantly, document how excess return is created in the portfolio construction process. In other words, they will look for managers who are able to ‘do good, while doing well’.