ESG integration: From fringe solution to mainstream

April 2023

Christian Felx, Head of Responsible Investment, Desjardins Global Asset Management

Responsible investment (RI) is on the rise. A growing number of investors are opting for investment solutions that promote sustainable prosperity. What's more, the fact that all stakeholders are taking a greater interest in responsible finance shows that RI is emerging as the new normal. And yet, plenty of people were still opposed to using environmental, social and governance (ESG) criteria just two years ago. How can we explain this turnaround, and what can we expect in the coming months?

More sophisticated approaches

RI strategies have come a long way, which is a big reason why RI has gained mainstream recognition in recent years. Portfolio managers have moved from rule-based exclusionary strategies to more sophisticated strategies based on analytical frameworks. This development has bridged the gap between sustainability and financial performance. We now know that using ESG criteria for investment allocation and selection can identify risks and opportunities that are sometimes overlooked by traditional financial analysis. This new paradigm is completely in line with a manager's fiduciary duty and has made it possible to debunk, once and for all, the myth of underperformance that sceptics had long maintained

Fighting climate change: Time for an inclusive approach

To overcome issues related to climate change, the consensus is that we must move toward a low-carbon economy. This transition has already begun. For businesses and investors, this means assessing risks and opportunities and all the challenges associated with long-term and uncertain issues.

We need an inclusive approach that works with issuers from all sectors of the economy. The role of an asset manager is to assess a company's ESG strategy in order to ensure its long-term financial performance. The role of an issuer is to ensure its sustainability while having a positive impact on society and the environment.

Overview of a few emerging trends

  • Carbon neutral by 2050: The quest for carbon neutrality will shape the RI landscape in the coming years, from data collection to investment decisions and engagement activities.
  • The "S" is key: Human rights and environmental (intergenerational) inequities are central to many ESG issues. Exacerbated by the pandemic, the social aspect of RI will be given special attention by investors.
  • The need for transparency: Greenwashing concerns have drawn the attention of regulators as investors demand proof that their investments have delivered the intended results. Greater transparency will be required to demonstrate the authenticity and sincerity of any RI process.
  • Impact investing: In addition to ESG integration, the market is gradually turning to impact investment solutions and processes to measure and understand the impact of RI practices.
  • New technologies: Artificial intelligence, mass data processing and unstructured data analysis are being applied to RI. These technologies will enhance data analysis and make investment decisions more efficient.

Toward the adoption of comparable, credible and universal ESG data

Regulatory bodies are moving to regulate ESG data disclosure, and this is a welcome development. Asset managers have been vocal about the poor quality of data and the lack of universal standards for a long time. However, with the increasing number in data providers and improved issuer disclosure, the quantity and quality of ESG data has significantly increased. Nevertheless, coverage remains uneven across regions and asset classes, and the proliferation of frameworks and data sources means that investors must be vigilant and careful.

The time has come to promote compliance with a few credible and universal standards. The recent creation of the International Sustainability Standards Board - External link. (ISSB) is definitely a step in the right direction.

RI is expanding across asset classes and strategies

Data availability initially favoured ESG integration in traditional liquid asset classes. More recently, we've seen a move into alternative asset classes, including real estate and infrastructure. Procedures and guidelines have been established for the incorporation of ESG criteria into the investment process. Furthermore, green buildings and wind farms are becoming available to investors, who now have access to responsible investment solutions across all asset classes.

Passive and systematic solutions have also been gaining momentum. Improved disclosure and quantitative data quality have made it possible to implement sophisticated portfolio screening and construction rules for customized solutions.

The importance of diversified expertise

Despite RI’s explosive growth, the lack of expertise to assess the quality and impact of the various solutions remains the biggest barrier to its universal adoption. That's why it's essential to invest time and effort to develop the right tools, to integrate the right resources and to develop the skills of the teams.

Education is the key to overcoming the current shortcomings. Many university programs now cover responsible finance, and financial institutions are deploying comprehensive in-house training programs. Beyond knowledge development, top portfolio managers are also careful to promote diversity in all its forms, including diversity of expertise, to foster the exchange of ideas necessary for innovation and continuous improvement.