Investors globally are becoming more engaged with the environmental, social and governance (ESG) factors that affect the well-being and smooth functioning of the global economy and markets. The widespread endorsement of the United Nations Principles for Responsible Investing initiative, which has over 1,500 signatories from over 50 countries, is a key example.
Two primary drivers of this trend toward more sustainable investing are the changing demographic landscape and increased regulatory focus.
Wealth managers globally are preparing for the great wealth transfer from the baby boomer generation to the millennial generation and female investors. Women are projected to control two-thirds of the world’s wealth by 2020 (according to MSCI’s issue brief, “2016 ESG Trends to Watch”), and millennials will increasingly become the world’s decision makers. Research also suggests that both millennials and women are increasingly looking to align their investment and financial goals with their values without diminishing their return expectations.
On the regulatory front, one notable shift toward support for sustainability-focused investing was the recent change in U.S. Department of Labor (DOL) fiduciary duty rules allowing managers to incorporate ESG strategies. Fiduciary duty is the legal mandate to act in the client’s best interest when making investment decisions (e.g., focus on returns); the new DOL guidance acknowledges that ESG factors “may have a direct relationship to the economic and financial value of an investment.” Other regulatory decisions globally, including the ongoing European Commission work to develop non-binding guidelines for companies to disclose nonfinancial information and the Financial Stability Board’s task force to develop a voluntary standard on climate-related financial disclosures for companies, are all helping.
Evolution of ESG
The focus on ESG is wide-reaching. For example, the effects of climate change are now collectively acknowledged by governments, regulators, global corporations, asset owners, asset managers and the broader investment community. More investors recognize the urgency of understanding, stress-testing and hedging climate risks. Also, more people understand supply chain effects – the impact businesses have on their immediate and broader communities and potential costs associated with poor decisions. Culture and conduct are ever more important in how the financial system fulfills its mandate of facilitating sustainable economic growth.
Sustainable investing is no longer only a topic of a heated debate – we’re seeing new policy initiatives and regulatory changes underway. For example, 177 countries (including the U.S.) have adopted the climate agreement from last year’s COP21 conference in Paris. Under this agreement, governments and corporations will set targets that will trigger changes likely to affect the longevity of many different business models. As we discuss in greater depth in our recent Q&A, it is imperative that investors start early with identifying winners and diversifying away from losers. At PIMCO, we believe companies that position themselves for the transition should be able to deliver steady performance, while for those inflexible or unwilling to change, the costs may prove severe.
Kwame Anochie is an account manager on PIMCO’s global wealth management team and a member of PIMCO’s ESG leadership team.