Climate Leads Investors’ Post-Pandemic ESG Priorities

Despite the ongoing pressures of the Covid-19 pandemic, investors have been keen to progress the climate change agenda ahead of the 2021 United Nations Climate Change Conference taking place in November.

With the UK playing host to this year’s conference and the notable presence of the US re-entering the 2015 Paris Agreement, many asset managers are looking again at their own climate policies.

Prior to the outbreak of the pandemic, sceptics had suggested that fund managers might retreat from their pledges when market volatility consumed them and investors became more concerned about performance in isolation from environmental, social and governance (ESG) issues.

However, rather than driving investor attention away from climate change, the pandemic has cemented interest.

Focusing minds

The Covid-19 outbreak has acted as a wake-up call for asset managers and investors alike. Many companies and sectors that displayed poor ESG characteristics prior to the pandemic have been found to be among the most badly affected as a result of the novel coronavirus.

There is a long-held misconception that investing with an ESG tilt comes at the expense of investment returns. The Covid-19 period has put to bed this myth once and for all.

During 2020, European sustainable funds broke new records in terms of inflows, assets, and product development, and ESG stocks proved more resilient during bear markets.

While many asset prices fell during the initial phase of the pandemic in 2020, investments with stronger ESG characteristics fared better than most.

Even before the pandemic, sustainable funds were outperforming their peers. Analysts at Morningstar recently reviewed the performance of some 4,900 funds. They found 59% of sustainable funds had beaten their traditional peers over a 10-year period through to 2019.

This has led fund managers to rush to launch new sustainable strategies into the market. In 2020, 505 new funds were launched in the European market, according to Morningstar data. Of those, 13% were styled as environmental funds. Some of these launches were remodelled strategies that were re-engineered from conventional mutual funds.

The newly launched and repurposed funds in 2020 brought the total number of European sustainable funds on the market to 3,196.

During a period of rapid social change – a pandemic, climate risks, racial inequality and depressed economies testing society’s resilience – investors have become increasingly interested in the ESG qualities of the companies in which they invest. However, climate has been a standout focus for many asset managers, driven by the priorities of their investors.

Climate fight

In January 2021, major shareholders in HSBC filed a climate resolution urging the bank to outline the measures being taken to reduce its lending to fossil fuel intensive companies.

Shareholders were reacting to HSBC’s October 2020 pledge that it would “reduce financed emissions from our portfolio of customers to net zero by 2050 or sooner, in line with the goals of the Paris Agreement”. HSBC was responsible for more than $86.5 billion in fossil fuel financing since the Paris Agreement was signed.

BlackRock recently highlighted the bank for its lending activities. The world’s largest asset manager called on HSBC to rein in its financing of the fossil fuel industry with two of Blackrock’s British pension fund client urging them to support the climate resolution.

With assets of $7.8 trillion, Blackrock is likely to play an influential role in setting the standard for smaller fund groups.

In an annual letter to CEOs last year during the height of the pandemic, chairman and CEO Larry Fink said: “Climate change has become a defining factor in companies’ long-term prospects… but awareness is rapidly changing, and I believe we are on the edge of a fundamental reshaping of finance.”

BlackRock has also outlined expectations for companies to disclose plans for transitioning to a lower carbon economy, as well as improving transparency about key stakeholders and business interests.

The asset manager has also pledged to divest from polluting companies in its actively managed funds – representing about a tenth of its assets – if it sees no improvements in the coming years.

Regulatory drivers

Regulation is also driving inflows into ESG strategies. The UK has already outlined plans to have corporate reporting rulesets in place aligned with the Task Force on Climate-related Financial Disclosures by the time of the COP26 conference in November. Major investors such as pension funds are affected by these reporting rules, as well as listed companies.

The European Union is close to finalizing its Sustainable Finance Disclosure Regulation, including a sustainability “taxonomy” that will help investors define the industries and companies aligned with a green economy.

In the US, the Biden administration has put climate change at the center of its four-year plan. However, this will require rethinking some regulations proposed during the final months of the previous regime that sought to limit investors’ ability to take ESG factors into account.

In December 2020, some of the world’s largest asset managers, representing $9 trillion in assets under management, committed to achieving net zero carbon emissions by 2050. Thirty firms signed up to the Net Zero Asset Managers initiative, including Fidelity International, UBS Asset Management, BMO Global Asset Management, and DWS.

These companies, along with other signatories, have committed to work towards ensuring their investment portfolios are aligned with net zero greenhouse gas emissions by 2050, in line with efforts to limit global average temperature increases to 1.5°C above pre-industrial levels.

The greater availability of data and the increasing importance of transparency are helping ESG factors become integrated in mainstream investment processes.

After the pandemic, the history books may show that 2021 was the year in which ESG came of age.