ESG underperformance last year is seen by pension funds as a “temporary setback”, and they intend to pursue investment strategies that seek environmental and social outcomes while also making money, research suggests.
ESG investing remains “central to long-term value creation” argues investment management expert Professor Amin Rajan, who surveyed 158 pension plans globally.
He found that investors had lost money on sector bets last year as energy stocks “gained the upper hand” over decarbonisation goals.
The professor – who leads Create-Research – also found that just over half of the investors in the survey were concerned about the ESG backlash, which is perceived to stem from the US.
Yet 79% of the 158 respondents – who in total represent €1.91 trillion of assets – believe that ESG factors “will not hurt performance in the long term”.
ESG strategies will suffer periodic setbacks, but those setbacks would have “little to do” with ESG investing per se and more to do with larger dynamics, the majority of investors appeared to believe.
Over the next three years, 53% of respondents expect the share of ESG investing in their active portfolios to rise, and 49% expect a rise in their passive portfolios.
Vincent Mortier, chief investment officer of asset manager Amundi, which sponsored the Create study, said: “Even the most casual markets observer will know that 2022 was a difficult year, but despite the hit to ESG strategies, it’s encouraging to see such optimism from institutional investors.”
Citing a survey respondent who said, “We want to see clear evidence that our ESG investments do well financially and do good socially”, Rajan said pension funds would evolve ESG investing with two goals in mind.
The first set is about investment basics, with 57% of respondents saying they wanted to minimise risks linked with ESG factors and 53% saying they wanted to enhance returns from related opportunities. A similar percentage seeks “double bottom line benefits” via societal and environmental returns, as well as financial returns.
The second set of goals included tackling the trade-offs between the environmental, social and governance pillars (49%) and reducing operational and reputational risks (34%).
The research also found that public equities and bonds were favoured over alternative asset classes for achieving net zero goals. This is because equities permit strong stewardship and proxy voting, and they offer ready liquidity as well as help pension funds target ‘pure play’ ESG business models, such as renewable energy and hard-to-abate sectors like cement and steel.
Bonds are the second preference (41%), and Rajan said that as more pension plans advanced into their ‘run-off’ phase due to ageing demographics, green, social, and sustainability-linked bonds became attractive.
Alternative assets come third (38%), with a preference for green infrastructure, followed by green buildings, private equity and private debt.
Private equity is well positioned to buy the worst ESG laggards and improve their green credentials both with and without tax incentives, noted the professor.
A further finding was that the list of criteria for selecting investment managers had grown, with importance given to value-for-money fee structures, ESG values in an asset manager’s own corporate culture.
Rajan said: “ESG investing has evolved – we are now seeing a more robust version coming into view with a strong focus on real-world outcomes and accountabilities as well as financial returns. This shift marks a defining moment in the next stage of ESG investing and one that signifies its firm place at the heart of pension portfolios.”
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