An air of cautious optimism permeated through the halls of the Morningstar’s sustainable investing conference in Amsterdam on Wednesday, painting a subtle yet intricate picture of the obstacle-filled landscape of ESG investing.
Asset owners are increasingly seeing ESG as a material factor, particularly when it concerns the climate and net-zero ambitions, according to a new Morningstar survey. Yet, major challenges remain, particularly in terms of regulation, data reporting and greenwashing. “It’s, you know, one step forward, two steps back, three steps forward,” said Arnold Gast, Morningstar’s director of ESG research, speaking to Investment Officer.
Gast likened the challenging ESG adoption process in fund management to the discussions during the 1990s about corporate accounting practices. The book ‘Accounting for Growth’ by Terri Smith exposed corporate accounting malpractices. It triggered a global debate that eventually led to the creation of global accounting standards in 2001.
“This was a famous book in the 1990s. Basically, what is a profit that a company reports? There were lots of scandals and debates, and we don’t have them anymore. That was part of maturing. We’re at the same stage,” he said, referring to ESG investing. “It will take maybe a generation, 10, 20, 30 years. It’s maturing, and it doesn’t go in a straight line.”
Materiality matters
For asset owners worldwide, sustainability and ESG evidently is no longer optional, it became clear at the conference. The latest update of Morningstar’s annual survey of 500 asset owners, with collectively nearly 11 billion dollars under management, shows ESG factors, in particular the E for environment, are broadly - 67 percent - embraced as material.
Despite persistent implementation challenges, allocations to ESG strategies are increasing, with environmental issues driving materiality–especially those related to climate change and the transition to net-zero, concluded the survey, conducted over the summer.
But it also showed that regulatory confusion has become a more significant challenge for asset owners, with the lack of clarity and rising costs cited as particular pain points. For Morningstar, whose business is built on collecting data and analysing it, the survey’s results underscore the relevance of its major focus on sustainability.
Kunal Kapoor, CEO of Morningstar, said it is becoming increasingly clear that professional investors are a leading driver of global change as they push and encourage the companies they entrust with their assets to consider the environmental and social impact they have on the world around them.
“If you’re an investor and insurance company, and you look at the portfolio today and the parts of the world that they operate in, how can you not take into account changing climate patterns and what it means for their ability to write policies and on profits on those policies? It’s just a fundamental part of analysing those companies,” Kapoor told Investment Officer. “So, yeah, I think investors and asset owners are gonna drive it because they see that.”
Clients want to be heard
“Many asset owners believe their voices are different than ever before,” he said. “If you unpack that, partly that’s because the people they’re serving expect them to have a different voice. So you could be running a very large state pension fund somewhere in the world today. The difference from 10 years ago is that 10 years ago, probably the citizens of that country who you’re ultimately working for may not have been paying attention. Today they do. And they express their opinions.”
Gast also referred to regulatory trouble over greenwashing at asset managers such as DWS and Goldman Sachs. Both were fined by the SEC, 19 million dollars and 4 million respectively. “This is why they are taking it seriously. But at the same time, they cannot go back in not reporting anything, or not participating in SFDR. They have to take it seriously…, moving away from the simple sign on the door. The crackdown, that is good, because it forces people to move away from the simple content. It pushes them to embrace complexity.”
‘Simple, but not simpler’
“As Einstein once said: ‘Everything should be made as simple as possible, but not simpler’. In some cases, we didn’t make things simple enough,” Gast added, referring to a famous quote about the dangers of oversimplification. “I think that both asset owners and regulators together will come up with solutions, with market standard definitions, hopefully with the help of better reporting by companies, because we were not all moving in sync.”
“The system is thinking that at some point, we will find the right rhythm and learn from each other,” he said. “I’m hopeful and actually optimistic about that. It’s hard work. Yes, it’s not built overnight, like financial accounting was also not in place straight away. Just like that, IFRS was designed.”
“It also points to the fact that this may be one of the most impactful activities, actually solving this data and reporting puzzle,” Gast said. “Because if we do that, then yes, we can move money, we can influence decision-making in the right direction.”