New EU regulation promoting responsible investment is coming to our shores and not before time, says Thomas Stokes, investment director at Aviva Investors.
Here’s our prediction: within five years your clients’ pension and investments will be invested “sustainably”.
We believe the fund managers of tomorrow will be increasingly judged not just by their investment performance, but also on how they approach environmental, social and governance (ESG) issues, such as climate change, inequality and social diversity.
Fortunately, these two aspects aren’t necessarily mutually exclusive. In fact, there’s empirical evidence that shows the opposite. For instance, a July 2013 Harvard Business School study found that, over an 18-year period, a sample of 90 ‘high-sustainability’ companies “dramatically outperformed” 90 low-sustainability firms in terms of both stock market and accounting measures.
Why are we so confident ESG investing is going to become more prominent?
Firstly, we believe there are powerful driving forces behind the demand for ESG investing; this isn’t just a fad. Let’s look at the situation today. Most people have relatively little knowledge of how their pension and investments are invested. Some people may know the name of their pension provider for example, but few will have an awareness of the specific companies and securities they have indirectly handed their money to. In their defence, as an industry we haven’t made it easy for investors to truly connect with their money.
On a positive note, just as people have become avid recyclers in recent years, they are now becoming more conscientious about where they’re investing. To give you some numbers, in a 2019 survey, 85 per cent of individual investors expressed an interest in sustainability focused strategies -up from 71 per cent in 2015. This trend seems set to continue, especially with events such as the COVID-19 crisis and the Black Lives Matter movement serving as a powerful reminder of the issues we face today. Ultimately, this push from clients will help to force the hand of the finance industry to do better.
Other than client demand, an imminent revolution in regulation will also have a huge influence on the industry.
How influential can regulation really be?
The answer is ‘very’. Can you remember smoking in restaurants and being able to take your shopping home in a free plastic bag? These unhealthy and unsustainable behaviours changed very quickly thanks to regulation.
In a similar fashion, we will also see a shift in the investment world as ESG investing becomes the norm. And, just like the restrictions on smoking and plastics, this change is in everyone’s best interests.
What is the regulation?
There’s new regulation currently being finalised by the European Commission, which is due to hit UK shores next year. For a financial adviser in the UK, it will mean that they will need to ask their client if they want them to recommend funds that take ESG into account.
At the same time, further regulations will require fund managers to be far more transparent about the ESG credentials of the funds they manage, and advisers will have to explain how they use that information in making their recommendations. The main objective of the new rules is to educate individuals on responsible investment, and, for those who are interested, to ensure they are provided with a suitable ESG solution.
These moves are just the first ripples in a coming wave of legislation. As ESG investing matures, regulation will strengthen and the definition of what an ESG investment is will become more defined.
A force for good
In essence, investment returns are not the only thing clients are going to be interested in the years to come. They will also want to ensure their money is being used responsibly to build a better world for themselves and for future generations.
The reason we’re so positive is because we believe these two goals are aligned. Moreover, these changes highlight a powerful truth: a more responsible financial industry can bring about a lot of positive change to build a fairer and more sustainable world.
Past performance is not a guide to the future. The value of an investment and any income from it can go down as well as up. Investors may not get back the original amount invested.
- Robert G. Eccles, Ioannis Ioannou, George Serafeim, ‘The impact of corporate sustainability on organizational processes and performance’, Harvard Business School, November 2014
- Morgan Stanley report 2019 and 2015