This year is the year of environmental, social and governance (ESG) investment. That’s what proponents of ESG want you to believe, and the signals are pointing in that direction. First, the VW scandal last year, where company executives were caught cheating emissions tests for cars, saw governance issues hit the headlines. The scale of the wrongdoing and the number of people affected led to much commentary on companies’ responsibilities to shareholders and the public. In turn it turned a spotlight to the pressure shareholders put on companies to act ethically.
Second, 12 December last year saw the historic COP 21 Paris agreement reached between 195 countries, marking the first-ever universal, legally binding global climate deal. The agreement aims to keep the rise in global temperatures to below 2 degrees. Among other things the countries agree that $100bn needs to be raised each year from 2020 to finance climate change projects or reduce greenhouse gas emissions. This represents the potential for a big injection of cash into the market.
The final, investment-specific, action this year is the launch of Morningstar’s Sustainability Ratings. Launched this month, the ratings and research house has ranked 20,000 investment funds for how sustainable the funds are, by ranking the sustainability of the companies in the funds.
The first results from Morningstar are pretty damning for funds labelled as ESG. Less than two thirds of funds with explicit sustainable or responsible mandates have been given the top Morningstar ratings, highlighting that a third of the sector is falling short.
Some have picked holes in the Morningstar ratings as being too simplistic and likely to lead investors to make fund choices based on a basic numerical rating. But anything that helps to increase the focus on the ESG industry and improve fund manager practices must be welcomed. As with any research tool or rating, it cannot be used in isolation.
However, despite this perfect storm approaching, the one piece of the puzzle that is missing is investors actually actively investing their money according to ESG principles. Until investor demand, and assets, rise asset managers will not feel the pressure to launch new products or change existing practices. It all rests on the British public.