Over the last decade, interest in ESG (environmental, social, and governance) investing has grown exponentially. Driven by increased public awareness of the importance of investing responsibly, this approach to investing has become so popular that nearly 90% of investors are considering it in some shape or form today.
So, what does the rise of ESG mean for the private wealth industry? And what’s the best way to implement an ESG strategy?
The evolution of ESG investing
While socially responsible investing may seem like a relatively new concept, this style of investing has actually been around for quite a while now. Indeed, it first emerged in the 1960s and 1970s, when socially concerned investors sought to address issues such as equality for women, civil rights, and working conditions.
A game-changing moment came around 20 years ago, however, when the United Nations published a report entitled ‘Who Cares Wins’ in 2004. This report highlighted the potential benefits of integrating ESG into investment analysis, asset management, and securities brokerage, effectively laying the groundwork for the mainstream adoption of ESG strategies we see today.
More recently, ESG has been a key focus of major regulators. In March this year, for example, the US Securities and Exchange Commission (SEC) adopted rules to enhance and standardise climate-related disclosures. These will help investors obtain consistent, comparable, and decision-useful information, and provide issuers with clear reporting requirements. In Europe, the Corporate Sustainability Reporting Directive (CSRD) is coming into effect in 2025. The aim of this regulation is to make companies in the EU more accountable for their environmental and social impact.
Understanding ESG criteria
The idea behind ESG investing is that, when assessing potential investment opportunities, investors consider factors beyond just financial performance. The ‘E’ refers to environmental issues. This component focuses on how a company affects the planet through its use of energy, its pollution and waste, and its natural resource conservation. The ‘S’ refers to social issues. This addresses a company’s business relationships and looks at factors such as employee diversity and labour standards. Finally, the ‘G’ refers to governance. This examines how a company is run and considers issues such as board composition and business ethics.
Given its broad scope, ESG investing has the potential to have a tremendous impact on society in the years and decades ahead. Not only could it incentivise companies to reduce their carbon footprints and adopt more sustainable production methods, but it could also lead to fairer labour practices and improved employee well-being.
Why ESG investing is booming today
As for why interest in ESG investing has exploded recently, a lot can be attributed to the growing awareness of climate change and the importance of protecting the environment. No longer are investors only focused on financial returns when deploying capital. Today, they are also focused on putting their money into businesses that look after the environment and provide sustainable goods and services. This interest in responsible investment strategies is particularly prevalent among younger investors. Some studies have shown that many younger investors are actually willing to sacrifice returns if it means that their capital is being invested responsibly.
Also driving interest in ESG, however, is research showing that ESG strategies can generate competitive returns while potentially lowering risk. Studies have shown that over the long term, companies that address their environmental challenges, treat their stakeholders well, and have lower levels of controversies tend to generate higher profit margins and returns for investors. For example, a 2023 study by Kroll, which analysed data on 13,000 companies, found that ESG leaders earned an average annual return of 12.9%, compared to an average 8.6% annual return from laggard companies. At the same time, studies have shown that low-rated ESG companies often have higher capital costs and higher levels of stock price volatility due to controversies and issues such as labour strikes, fraud, and accounting irregularities. Given these dynamics, funds that focus on ESG can be very appealing to those looking to build robust long-term portfolios.
ESG and private wealth management
The impact of this shift in investor preferences on the wealth management industry continues to be significant. Already, total global ESG assets under management (AUM) have surpassed $30 trillion, according to Bloomberg Intelligence (BI). However, the latest BI ESG report projects that ESG-related AUM is likely to surpass $40 trillion by 2030. That would represent more than a quarter of the total global AUM.
Given the increasing focus on socially responsible investing, financial advisers today need to have a strong understanding of ESG issues. This means staying up to date on things like ESG ratings, methodologies, products, and best practices. Resources like Morningstar, MSCI, and the CFA Institute can be helpful here.
Looking ahead, adviser/client conversations are likely to be focused on ESG preferences as well as traditional financial goals. For example, they may involve in-depth discussions about a client’s values and sustainability priorities. As ESG investment priorities continues to gain momentum, those who can effectively integrate ESG strategies into their offerings and provide clients with tailored solutions will be best-positioned to thrive.
Challenges associated with ESG investing
It’s worth noting that ESG investing does come with some challenges, for both advisers and investors.
Data issues are one such challenge. Typically, investors rely on ESG ratings or ESG scores when investing with an ESG focus. These ratings – provided by financial data companies – measure a company’s exposure to ESG risks. The problem is that standardised and reliable ESG data can be limited, making it difficult to accurately assess a company’s ESG performance.
Greenwashing is another issue. This refers to the misleading use of ESG credentials. Advisers must be vigilant against greenwashing and ensure that their clients are investing in companies with genuine ESG credentials.
Finally, financial advisers need to help their clients strike a balance between generating financial returns and making an impact. Finding the right balance can be complex, but by understanding their clients’ values and long-term goals, advisers can develop personalised ESG investment strategies that deliver both competitive returns and a positive contribution to the world.
How IQ-EQ can help
At IQ-EQ, we have decades of experience in the ESG investing space. Our team of experts can help you integrate sustainability factors into your investment analysis and decision-making, manage ESG risks, and provide all the necessary documentation and disclosures for compliance. We can also provide customised structures such as trusts, holding companies, and partnerships, and other tools for intergenerational wealth planning. To learn more about how we can help you with ESG investing, get in touch.
About the author
Deanna is a Client Director in the Cayman Islands for IQ-EQ. She has over 20 years of experience in the finance industry with specialist knowledge in business development, regulatory compliance, hedge funds and alternative assets. Deanna is also a chartered accountant with over 15 years post-qualification experience.
