ESG Will Become More Integral in the Next 36 Months, Alternatives Investors Say

But the industry has some way to go: 69% of investors surveyed by Preqin say they do not require ESG reporting from fund managers they invest with

Amid a growing global focus on sustainability, alternatives investors say they expect environmental, social, and governance (ESG) factors to play an increasingly vital role in their allocation decisions. Indeed, almost two-thirds (61%) of institutional investors surveyed by Preqin said that ESG will become more integral to the industry in the next 36 months. Just 7% said ESG will become less integral to the industry in that time. In the words of one investor: “ESG as a mandate will become more integral: ESG first, investment performance second.”

But there are a number of hurdles in the way before ESG becomes a priority for the vast majority of investors. For a start, the industry still lacks a standardized approach to ESG – a way for companies and fund managers to discuss, measure, and verify the often varied inputs and results that make up ESG analysis.

Some progress has been made: ESG assessment has shifted from a way to gauge corporate and social responsibility to an investment proposition. This includes performance indicators which show that sustainable practices can generate substantial returns, and mitigate certain risks. However, investors are anything but unanimous in their views on the significance – and effectiveness – of ESG as a decision driver.

Preqin surveyed almost 400 alternatives investors around the world for their views on the current state of ESG, how they take ESG into account today, and where they see it going in a rapidly changing environment. Just over half (213) of those we surveyed were located in North America, another 119 were in Europe, and 31 were in Asia, with the rest scattered across other parts of the globe. Broken down by asset class, respondents were fairly evenly divided, with private equity investors accounting for the most (179) and natural resources the least (92). The remaining investors were active in real estate, hedge funds, private debt, venture capital, or infrastructure.

Perhaps the most notable responses came in the areas of how – or, indeed, whether – respondents considered ESG when investing in a fund, their perceptions of the performance of ESG-focused funds vs. non-ESG funds, and their views on the growing importance of ESG considerations in financial markets.

Performance of ESG-Focused Funds Does Matter
More than one-third of respondents have refrained from investing in a fund because it had an inadequate ESG policy; 26% said this occurs “sometimes” and 9% said it happens “frequently.”

And while 23% said they have never turned down a fund due to its ESG policy, 42% told us that they do not consider ESG principles during fund evaluation at all – a clear indication that there is still some way to go before ESG can be considered mainstream.

In terms of returns, roughly four in five respondents believe ESG-focused funds perform at least as well as those that do not focus on ESG. Twenty-three percent claim that ESG-focused funds tend to perform better, while more than half (56%) say they performed “about the same.” The remaining 21% think ESG-focused funds tend to perform worse.

ESG’s continued integration into asset allocation will, as one investor noted, “predominately depend on its ability to produce consistent returns and keep pace with traditional alternative investment.”

Many Investors Still Lack an ESG Policy
When asked what proportion of fund managers they require ESG reporting from, 69% of respondents said none. And while 13% of respondents said they require reporting from all of their managers, the rest were roughly evenly divided into four categories: 6% ask it of 1-25% of fund managers, and 3% ask it of 76-99% of them.

As for whether or not investors have an ESG investment policy in place, or plan to implement one, a significant proportion of respondents do not have one in place, and nor do they plan to – this view was espoused by more than half of respondents in some asset classes. In the other direction, 35% of infrastructure investors have an ESG investment policy already in place, and a further 11% plan to within the next 12 months. Similarly, 32% of private equity respondents have a policy in place and another 14% plan to in that time. Following on, 44% of real estate respondents either have a policy or plan to (31% and 13%, respectively), 42% of venture capital investors answered accordingly (27%, 15%), and 37% of private debt respondents (25%, 12%). Those who answered “unsure” ranged from 9% (private equity and real estate) to 15% (venture capital and natural resources).

At least some of this indifference was evident in verbal responses from investors, including one who told us that until there is a “rational ESG policy that ranks ESG apples with ESG apples, investing based on ESG policies doesn’t make sense.” Another suggested that “good analysts have always incorporated ESG factors into their work,” and that the current ESG focus is merely a “branding/marketing movement.”

Public Perception Is a Key Rationale for an ESG Policy
Still, many of the investors we surveyed see the appeal of an active ESG policy – including in the areas of risk management, public perception, and returns. While 39% of respondents “don’t pay attention” to ESG, 34% cited stakeholder/public perception as a key appeal of an active ESG policy, 24% pointed to risk management, and 12% highlighted either risk-adjusted or absolute returns (8% and 4%, respectively). Another 17% cited “future-proofing compliance” as the main appeal.

And while just 2% of respondents highlighted “good business practice” as the key appeal, and another 1% pointed to the moral imperative, at least one investor suggested that sustainable investing “should be a priority” from a societal standpoint. Either way, it seems clear that growing client demand is adding pressure to move in this direction.

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