Environmental, social and governance (ESG) will embed deeper into the investment world in 2020 as complexity triggers more sophisticated strategies across the industry, State Street Global Advisors (SSGA) argues in a new paper.
ESG is set to become both a “mainstream boardroom” issue and a “fiduciary responsibility” in the year ahead, the SSGA report says, supported by new global disclosure standards.
SSGA says the Sustainability Accounting Standards Board (SASB) reporting framework will assume centre stage in 2020 as the industry benchmark for ESG disclosure.
Since launch just over a year ago, the number of investors reporting against the SASB standards has grown rapidly, although from a low base with just 100 or so firms using the ESG reporting process as at last September.
However, the SSGA paper says the SASB standards are poised to make further inroads, driven by underlying financial reference points, easy-to-use tools and integration with the Taskforce on Climate-related Financial Disclosure (TCFD) reporting process.
“With ESG data under scrutiny, investors are beginning to focus on the quality of the ESG data they use,” the SSGA report says. “Central to that understanding of quality is that ESG data should be financially material, consistently reported by companies, and comparable across peer firms.”
The SASB standards should underpin moves to include ESG as a fiduciary duty, the paper says. Last year, for instance, the NZ Sustainable Finance Forum raised the prospect of expanding fiduciary duty to accommodate ESG factors.
“Investors now have the ability to quantify and compare companies’ operational performance on the ESG risks and opportunities that matter most to their industry,” SSGA says. “Collectively, both greater awareness and access to data are moving investors towards the view that considering ESG issues in the investment process is part of honoring one’s fiduciary duty.”
As well as putting sustainability firmly on the boardroom agenda, the SSGA report says during 2020 ESG strategies will become more complex while investors assume greater responsibility for exclusions.
More complex ESG investments, however, will have consequences for portfolio construction techniques and product design.
“In incorporating ESG into index portfolios, most institutional investors still seek market-rate returns,” the paper says. “In order to address growing complexity and still achieve these returns, investors will need to get comfortable with more nuanced, and potentially more algorithmic-oriented, ways of building portfolios.”
Furthermore, as benchmark providers incorporate ESG factors into indices, passive investors will have easier access to sustainable strategies. The growth of indexed sustainable investment will place even more pressure on active managers who eschew the approach “to explain why they don’t see ESG as a portfolio risk or investment opportunity”, SSGA says.
During 2020 investors will also question their reliance on third-party ESG data supplier to build exclusion screens, the paper says. Authored by Rakhi Kumar and Alison Weiner – respectively, SSGA head of ESG investments and asset stewardship, and ESG investment strategist – the report says the diversity and low correlation between outsourced screening approaches has caused some confusion.
“Because of these differences and the increased scrutiny of all ESG investment products by both regulators and activists, in 2020, we expect it to become increasingly untenable for investors to fully outsource their exclusionary screening methodologies and keep their involvement at arm’s length,” the SSGA paper says. “As oversight of this area tightens, we expect to see more asset managers taking greater ownership of their exclusionary processes.”
The ‘Five ESG Investing Trends to Watch in 2020’ paper follows on from SSGA’s longer ‘Into the Mainstream’ report published late last year.