More than half the money invested in funds in Europe could be managed by explicitly ESG strategies by 2025, according to PwC Luxembourg.
That ‘imminent paradigm shift’ is expected to reshape the continent’s asset management industry, as ESG – or environmental, social and corporate governance – investing becomes the norm in the first half of the decade.
That is being driven by sweeping new European Union regulation and a shift in the behaviour of institutional investors, which could lead to what PwC termed a ‘disconnect’ with fund management groups, while also highlighting the latest evidence that coronavirus had accelerated the pace of change.
Today, Europe has already become the major global player in sustainable investing. ‘ESG assets’ amounted to €1.7tn (£1.5tn) at the end of 2019 or 15.1% of the total in European funds, according to the Luxembourg arm of the accounting and consulting group, which detailed its finding in a report called The Growth Opportunity of a Century.
It is predicted that the absolute level of those ESG assets will at least triple, so they make up between 41% and 57% of the total in funds in Europe by 2025, reaching between €5.5tn and €7.6tn.
The lower figure was said to be a conservative forecast, based on a continuation of current market trends and product launches, with asset managers ‘simply aligning’ with new regulation.
The higher figure sees the proliferation of sustainable products ‘redefining the current landscape’ and making up the bulk of launches.
Though many specifics are still being hashed out, pivotal to that is the development of new EU rules, with the Sustainable Finance Disclosure Regulation set to come into force in March next year. A new ‘taxonomy’, codifying the parameters around ESG investing is expected to be fully implemented by 2022.
The major non-EU European markets of Norway, Switzerland and the UK are expected to align with the changes.
PwC defined ESG funds as those classified in the two ESG categories under the new rules for future assets, while for the past and present they were those classified as ESG by data providers Lipper and Morningstar.
If the changes sound like an overhaul of the asset management industry, that is what the largest investors themselves are expecting, with ‘a recent surge in regulatory momentum embedding ESG as a central tenet of the investment landscape’, according to PwC’s Steven Libby and Olivier Carré.
Among the 300 institutional investors surveyed for the report, including insurance companies and pension fundsm, 99% believed there would be an eventual convergence of ESG and non-ESG products, with a significant majority expecting this to occur by 2022.
While Norway’s $1.1tn sovereign wealth fund made headlines for beginning a divestment process relating to oil, gas and coal companies last year, that kind of action looks set to become the norm rather than the exception among European institutional investors.
A huge 77% told PwC they intended to stop investing in ‘traditional non-ESG compliant products’ within the next two years. However, only 14% of the 200 asset managers responding said they were planning to stop launching non-ESG products in the same time period.
PwC said this ‘fundamental disconnect’ highlighted the urgency with which fund groups needed to make choices about their product lines to meet shifting investor interest.
Europe in ‘pole position’
Europe is also set to maintain its leadership in the ESG space. At the end of last year, European ESG funds accounted for 69% of the global total. Under the two scenarios outlined, that share is expected to rise to between 71% and 74%.
Beyond the regulatory backdrop, this will be pushed by the ‘green recovery’ which policymakers want to stimulate in the region. The report points out that a fifth of the €750 EU recovery plan will be allocated to funding green transport, clean industry and green home renovations.
The pandemic was also said to have shone a light on the ‘materiality of ESG’ issues’.
Citywire AAA-rated Mike Fox, whose £2.2bn Royal London Sustainable Leaders fund has enjoyed net inflows of more than £1bn this year, told Funds Insider in May he thought the pandemic had done more to bring sustainable investing into the mainstream in 10 weeks than the previous 10 years.
Retail investor demand for is currently lagging the sustainability drive in institutions, with 41% of 800 private investors surveyed currently incorporating ESG considerations into their investment strategies.
However, it is expected to catch up quickly and ‘as the millennial and subsequent generations become more active, retail investors are likely to take up the ESG mantle’, according to the report.
The Investment Association recently reported that net retail sales for responsible investment funds were four times higher in the first half of 2020 than the same period in 2019.
Still a ‘maze’
Jason Hollands, managing director of online stockbroker Bestinvest, said that investors still had a to navigate a ‘maze’ of options when choosing responsible funds.
For one, whether or not sustainable funds outperform the wider market remains contentious. Hollands pointed out a significant challenge was that funds in this growing areas were often quite new, making performance records short. Of the 148 funds in the Investment Association’s sectors that he identified as investing with intentional ethical or ESG criteria, a third have only been launched in the last three years.
However, he agreed that updated EU rules, likely to come in next year and expected to be adopted by the UK, would continue to make sustainable investing mainstream.
‘In the past, ethical or ESG investing was sometimes an approach kept under the counter by financial advisers, discussed only with investors who proactively expressed an interest in it,’ he said.
‘However, under a proposed amendment to EU regulations, firms providing financial advice and portfolio management services will be required to assess their clients’ ESG preferences.’