Analysing the opportunities, challenges of the ESG investing sector

ESG is not only a risk management tool, but an investment strategy that can generate value for investors.

As the ESG and responsible investment market grows, the industry is evolving in the way its strategies are created and implemented, said Mark Spicer, director climate change and sustainability, KPMG Australia.

Spicer and Emily Whelan, ESG advisory sales, UBS, recently discussed the state of the ESG investing industry.

"Value creation and ESG is another lens that investors need to look through," Spicer said. "They're used to thinking of business in terms of dollars, and value creation is a broader way of thinking about the operations of corporates that you're going to invest in. There's a whole bunch of language to understand and a whole lot of data that needs to be generated and understood, and converted into value by the asset managers."

The ESG investing industry is growing by leaps and bounds - the Responsible Investment Association Australasia (RIAA) released its annual Responsible Investment Benchmark Report, which shows that the total pool of responsible investments has soared to $1.2 trillion, from $983 billion in 2019. Money managed using responsible investment techniques increased from 30 to 40%, faster than the increase of professionally managed funds in 2020, which grew overall by 2%.

However, asset managers need to focus on embedding ESG processes and demonstrating how they generate value through ESG, Spicer said.

"The industry needs to be able to understand ESG performance and bring it into the decision making," Spicer said. "That process is immature, and in the RIAA findings, what we find was most of the respondents could make commitments to ESG, but not many of them could describe how they are systematically thing about ESG across their business."

The precipitous growth of ESG investing in the last two to three years presents a potential risk, Spicer noted.

"I think the fact that we have such a significant growth this year and over the last two to three years, it would be a struggle for the new asset managers to integrate the process thoroughly across their investment processes," he said. "Understanding that ESG is a value creator is a strong first step, but unpacking that and embedding that into how you select stocks is complicated and it takes time. My concern is that there are lots of people who are saying it and not doing it."

If the starting point for investment managers is embedding ESG in the investment thesis, the decision making around that process has to start at the top, Spicer said.

"You need your CEO and CIO understanding where that is and how you're talking about it, and then it pushes down to the investment decision where you're explaining to the investment managers," he said. "They then have to demonstrate that there are decisions that are being made in line with it."

These questions aren't just being posed to investors and fund managers, Whelan said.

"It is a question that a lot of market participants are asking themselves now," she said. "There is a real rush to be ESG friendly, to be meeting the standard of your clients or funding from that point of view. Everyone has moved very quickly to get up to speed, to put statements out and targets out and get the granular data out around ESG

"Now that the market around ESG is becoming more commoditised, it's more expected to be common knowledge , and what I'm really seeing is whether you're an organisation or you operate as an investor, what they're considering is how does the purpose align with profit."

"As much as everyone is increasingly putting out net zero targets, an organisation needs to have, and are developing a deeper understanding of what their purpose is," Whelan said.

Read more: ESGRIAAEmily WhelanKPMG AustraliaMark SpicerUBS