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Advancing environmental, social and governance investing

A holistic approach for investment management firms

Sean Collins

Key messages
  • ESG-mandated assets in the United States could grow almost three times as fast as non-ESG-mandated assets to comprise half of all professionally managed investments by 2025.
  • An estimated 200 new funds in the United States with an ESG investment mandate are expected to launch over the next three years, more than doubling the activity from the previous three years.
  • The use of artificial intelligence (AI) and alternative data is giving investment managers greater capabilities to uncover material ESG data and possibly achieve alpha.
  • Investment management firms that act today to transition from siloed ESG product offerings towards enterprise-level implementation will likely capture a greater percentage of future ESG asset flows.
With the increasing emphasis on social accountability worldwide, many investment management firms are incorporating environmental, social and governance considerations into their decision-making, aided by emerging technologies such as AI and sophisticated analytics. Not only could this help to engender trust with investors, it could also open up possibilities for alpha.

The sustainability movement is growing

SOCIAL consciousness has spread throughout many facets of life and many companies are making a concerted effort to align with these principles. This effort has likely contributed to the steady rise in the media coverage afforded to “sustainable” brands over the past two years.1 Evidence suggests a similar growth in a desire for what are characterised as “sustainable” or “socially responsible” investments. Globally, the percentage of both retail and institutional investors that apply environmental, social and governance (ESG) principles to at least a quarter of their portfolios jumped from 48 per cent in 2017 to 75 per cent in 2019.2 While directing investments based on one’s values has been around for decades, discussions between advisors and their clients about ESG investing have become commonplace.

Despite greater adoption within the investment community, the varying approaches to ESG limited by investment management firms, regulators and investors suggest the full potential has yet to be realised. This will likely happen if investment managers routinely consider ESG metrics in all investment decisions.3 While this scenario seems unlikely in the short term, the Deloitte Center for Financial Services (DCFS) expects client demand to drive ESG-mandated assets to comprise half of all professionally managed investments in the United States by 2025. According to the DCFS, investment managers are likely to respond to this demand by potentially launching up to a record 200 new ESG funds by 2023, more than double the previous three years. Firms may capture a greater share of this growing allocation to ESG by utilising emerging technologies for incorporating quality ESG data into the investment decision process, developing products with clear ESG objectives and embracing an ESG-driven culture across the organisation to gain credibility with investors.

As emerging technologies, such as AI, enable better-quality ESG data and the regulatory landscape becomes clearer, institutional and retail investors are expected to increasingly demand that ESG factors be applied to a greater percentage of their portfolios. In this scenario, ESG assets should continue to grow at a 16 per cent compound annual growth rate (CAGR), totalling almost US$35 trillion by 2025 (figure 1).

New ESG fund launches to accelerate as demand spreads across geographies and investor types

The largest amount of sustainable investing assets is in Europe, totalling £11.3 trillion, followed by the United States with £9.6 trillion.4 While Europeans may hold the highest amount of ESG-aligned assets, much of the world’s recent growth in this space may be attributed to investors’ increased interest in the United States. From 2014 to the beginning of 2018, assets under management with an ESG mandate held by retail and institutional investors grew at a four-year CAGR of 16 per cent in the United States, compared with 6 per cent in Europe.5

Flows into ESG funds in the United States picked up the pace in 2019. Barring a dramatic turnaround in the final few months of 2019, equity and bond ESG unit trusts and exchange traded funds (ETFs) are likely to achieve record inflows for the fourth straight year.6 Flows into sustainable funds reached £7.1 billion through the first six months of 2019, compared to £4.4 billion in all of 2018.7

The driving force behind ESG at investment management firms is evolving and leading to increased fund launch activity. Client demand from both retail and institutional investors is now the top reason reported by money managers to incorporate ESG factors into investment decisions.8 Client demand for ESG mandates has increased over the past three years, supporting the rise in investment management firms’ product portfolios.9 DCFS expects a record number of ESG fund launches over the next three years as client demand increases. Investment management firms may benefit from this rise because ESG funds tend towards active management, with 92 per cent delivered through actively managed portfolios.10

The ESG investing regulatory landscape remains fluid globally

While many clients are becoming comfortable with incorporating ESG into their portfolios, there are some concerns about the transparency and quality of ESG disclosures. Some institutional investors petitioned the Securities and Exchange Commission (SEC) in the autumn of 2018 for rules to harmonise ESG investments.11 Without a consistent framework governing ESG principles, investors are left to navigate through the seemingly ever-changing landscape of definitions. Providing consistent definitions for “environmental,” “social,” and “governance” will likely generate more efficiency in the ESG data value chain and drive more effective investor engagement—including between asset owners and asset managers.

Regulators have recently been demanding more depth and transparency from public firms regarding their environmental impact. Bringing uniformity to the ESG taxonomy seems to be the goal of both US and global regulators—although both appear to view ESG investing through different lenses.

Traditionally, US disclosure requirements from the SEC on shareholder resolution votes have provided investors with information concerning a company’s ESG practises. Investment managers have utilised these disclosure rules to influence a corporation’s adoption of ESG principles. Updating disclosure requirements to include language related to ESG has received attention from the Congress, with a proposal that requires companies to include ESG metrics in their annual SEC disclosures recently passing out of committee.12 The proposed banknote calls for a committee of industry experts to recommend specific ESG metrics to the SEC for required disclosure.13

Apart from disclosure rules, an Executive Order released in April 2019 directed the Department of Labour, through its power granted under the Employee Retirement Income Security Act (ERISA), to review all pension fund investments to determine whether the funds’ implementation of ESG principles excluded energy companies and thereby hindered the return of plan assets.14 In other words, US-based institutional investors, such as pension funds subject to ERISA, must demonstrate that ESG investing benefited the long-term growth of plan assets.

In the European Union (EU), the European Securities and Markets Authority (ESMA) recently clarified questions surrounding ESG investments. ESMA proposed several additions to existing regulations that set out how financial market participants and financial advisors must integrate ESG risks and opportunities in their processes as part of their duty to act in the best interest of clients.15 The proposed amendments dictate that advisors must explain why sustainability factors were not considered as part of the process. The necessity of ESG integration in investment decisions might help explain why 97 per cent of institutional investors in Europe are interested in ESG investments.16 EU regulators have also taken the lead in developing a common ESG taxonomy to facilitate sustainable growth financing and investing.17 The stricter standards now applied to sustainable investments may explain why the percentage of ESG assets to total assets shrank in Europe between 2014 and 2018 even as interest in sustainable investing increased.18

In Asia, regulators have determined that increasing disclosure requirements about sustainability practises can encourage foreign investment.19 In 2018, the Chinese government, in a bid to increase transparency and investment, announced that listed companies and bond issuers will be required to disclose ESG-related risks.20 Singapore was an early adopter of ESG-related standards in Southeastern Asia, which had a positive effect on the development of its capital markets. Investor confidence in the quality of ESG data was established in Singapore after sustainability reporting was mandated in 2016.21

Globally, while different regulators may have taken different approaches to ESG, similar outcomes for investors may be generated. Ultimately, all investors stand to benefit from greater transparency of ESG factors in the investment process. Frameworks such as those created by the Sustainability Accountancy Standards Board (SASB) can help companies report material information related to ESG in a consistent manner. Some companies have recognised that the increased value placed on transparency by investors can benefit them and have begun reporting performance on relevant ESG factors in much more detail than would be otherwise required by regulators. For example, BP p.l.c. disclosed to investors that it is testing blockchain to track natural petrol produced using more environmentally friendly methods throughout its supply chain.22 Whether it be from the regulators or companies themselves, the trend of greater ESG data disclosure is likely to only increase.

Emerging technologies create opportunities for alpha and ESG product innovation

Some investment professionals have expressed concern that alignment with ESG principles may hinder performance. However, a recent research study demonstrates that ESG metrics may in fact aid the quest for alpha. The study back tested ESG metrics for materiality and found that a strategy that solely based its investment decisions on these metrics outperformed a global composite of stocks, strengthening the case for an active ESG investment strategy.23 As a result, ESG may provide an opportunity to both meet client demand as well as improve returns.

While back-testing supports the case for finding alpha with ESG data, the challenge remains for investment managers to apply current ESG data to their investment process and client reporting. Much ESG data, such as carbon emissions, is provided inconsistently across companies and industries. Almost 80 per cent of investment managers agree that they could improve client service by providing performance related to an investment’s ESG impact in addition to financial performance.24 However, only 44 per cent of managers share ESG data with institutional clients and even less (30 per cent) do so with retail clients.25

This conundrum of wanting to build material ESG data into the investment process and report ESG performance to clients yet finding it difficult to do so is largely due to the inconsistent availability and quality concerns of data. Global investment managers describe inconsistent data across assets as the biggest barrier to integrating ESG into investment processes.26 ESG disclosures tend to be produced by larger companies with more resources. Skewed disclosure may cause ESG investments to flow towards the largest companies even though smaller firms may have a similar or better impact regarding ESG issues.27 Investment management firms have recognised this disconnect and as a result, spending on ESG content and indices is expected to rise from 2018 levels by 48 per cent to US$745 million in 2020.28 Larger investment management firms have accelerated their spending on ESG data and tend to supplement it with proprietary metrics.29

With greater standardisation of ESG measures progressing slowly, advanced data analytics has become an essential component of ESG analysis. Investment management firms can leverage AI, such as machine learning, as well as alternative data to develop ESG metrics for analysing investments, making decisions and informing investors. By aligning advanced analytics tools with sustainability metrics, investment managers may be able to move beyond simple screening methods to actively make the case for alpha (see sidebar, “Innovative firms provide solutions for integrating ESG data into investment analysis”).

Innovative firms offer solutions for incorporating ESG data into investment analysis

TruValue Labs utilises AI to continuously monitor more than a million data points based on the SASB framework to track ESG-related performance over time.30 This approach allows investment managers to test the materiality of ESG data on their portfolios, which may help in future outperformance.

Another firm, Arabesque, constructed its tool around the core principles of the United Nations Global Compact to identify financially material ESG issues.31 Its platform provides a philtre for screening out companies based on personal values and uses self-learning quantitative models and big data to assess the performance and sustainability of companies. A more comprehensive set of ESG data enables investment managers to make more informed ESG investment decisions.

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AI allows investment managers to uncover additional material data that may not have been disclosed by a company. One investment management firm uses an AI motor to scan unstructured data to identify material ESG data and then prioritise investments with low valuations for the highest expected return.32 This approach may help gain insight into, say, a company’s carbon emissions regardless of whether the company chooses to report them. The AI motor also searches unstructured data such as patent filings to identify companies that may be close to deploying cutting-edge low-carbon technologies. Identifying these types of investments before the companies tout their achievements may be the basis for higher future returns.

ESG ratings firms also utilise alternative data in their ratings processes. MSCI Inc. estimates that only 35 per cent of the data inputs used to compile a company’s ESG rating come from voluntary company disclosures.33 In one case, the firm used satellite imagery to identify material risks to the environment and the safety of workers in a mining company’s operations to fill the gap between company disclosures and material ESG data metrics.34 As a result, the use of alternative data to identify risks and opportunities for ESG investments is expected to accelerate over the next year.

As ESG gains greater acceptance with portfolio managers, differentiation often becomes critical. Going beyond transparency into product customisation may be the future of ESG product innovation. About 68 per cent of investment managers believe that much of the growth in ESG investments will be fuelled by product customisation.35

Yet, as mentioned previously, while ESG is a priority for institutional investors, only 23 per cent have integrated ESG principles throughout their organisations and 30 per cent have separate ESG and investment teams.36 This presents a significant opportunity for investment managers to deliver customised solutions for clients who want ESG to play a larger role in their portfolios but lack an implementation road map. DWS Group and Blackrock were able to provide such guidance to a large European pension fund in 2019. By each tailoring a unique ESG strategy based on the pension fund’s philosophy to favour companies with strong corporate governance and to avoid certain industries, the two investment management firms were able to bring two new sustainable ETFs to market, each garnering more than US$800 million inflows on their first trading day.37 The success of these launches highlights the acceleration of interest in US retail ESG funds by a diverse set of investors.

Looking deeper at customisation, invest-tech firms Open Invest Co. and Ethic Inc. have developed platforms that allow investors to choose among environmental, social, or governance themes.38 Investors can customise their portfolios by adding or removing specific companies through direct indexing.39 Some traditional investment management firms have taken notice and are trying to increase their ESG product offerings by developing their own platforms. John Hancock Personal Financial Services designed a platform known as COIN, which is accessible from any device and provides investors with the opportunity to directly own shares of companies that align with UN Sustainable Development Goals.40 The COIN platform may strengthen relationships by putting updates on the portfolio’s ESG performance at the client’s fingertips.

The need for credibility expected to lead the next wave of ESG-principled investing

There are likely to be winners and losers in the competition for ESG asset allocations. It could be crucial for investment management firms to recognise the importance of ESG and devote more resources to ESG product development to not autumn behind peers. The overwhelming majority (89 per cent) of investment managers believe sustainable investing will not dissipate, while the same number indicate their firms will devote more resources to this area in the next two years.41 Differentiation becomes much more difficult with many firms now preparing to expand ESG investment options.

ESG is a lens into effective risk management and an avenue to optimise performance. It has to be credibly embedded into the investment management business model, all the way through to attracting talent.

—Kristen Sullivan, Americas region Sustainability Services leader, Deloitte & Touche LLP

Success could flow to the investment management firms that can align their brand with ESG principles. The most effective method to gain traction may reside in the level of credibility the investment management firm has achieved from investors as opposed to its menu of ESG products. Today, consumers often reward companies that appropriately match their brand to their actions. An investment management firm may earn credibility with ESG-minded investors by fully embracing the influence of ESG issues across its organisation and demonstrating its commitment by detailing actions taken to align with these principles. Investment managers may find it difficult to effectively compete for capital allocations without a client-centric ESG strategy that encompasses credible ESG disclosure practises.

Capitalising on a socially responsible future

The recent uptick in investor demand for ESG suggests investment management firms should take action today to maximise the ESG opportunity. The future wave of growth in ESG investing will likely not be driven by screening out “sin” stocks but could instead be fuelled by managers using high-quality ESG data to increase the opportunity for alpha. A burgeoning ecosystem of customised ESG products and platforms presents investment managers with opportunities to further their value proposition to clients.

Investment management firms can take action today to enhance their likelihood of launching a successful ESG programme:

  • Understand the intermediary and end-investor expectations for ESG mandates
  • Develop a product portfolio that meets client expectations
  • Communicate and educate investors about the social benefits of the ESG programme
  • Adapt ESG principles throughout their firms to gain credibility as an ESG product provider
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Investors will still take performance into account when selecting an investment manager. However, investment management firms may find that ESG metrics enhance the potential to generate alpha as well as draw in new clients. Having sustainable products on offer might be a necessary first step, but long-term success is likely to depend on the ability to demonstrate to investors that the firm has taken on sustainable practises in an all-encompassing way. The ever-increasing expectations of investors and regulators will probably necessitate a proactive approach. Investment management firms should identify any gaps by re-examining their processes through an ESG-principled lens, with an eye on what is most important to today's investors. By 2025, half of all professionally managed assets could be subject to an ESG mandate. For an investment manager to capture a greater share of growth in assets under management, credibility with investors is likely to be key.

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  1. Quid, “Which brands are successfully positioning themselves as ecofriendly?,” 23 May 2019.

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  2. BNP Paribas, “The ESG Global Survey 2019,” 2019.

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  3. Crystal Kim, “Could ESG become the wrapper for all investing?,” Barron’s, 23 June 2018.

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  4. Global Sustainable Investment Alliance (GSIA), 2018 Global sustainable investment review, 1 April 2019.

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  5. Ibid.

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  6. Billy Nauman, “ESG money market funds grow 15% in first half of 2019,” Financial Times, 15 July 2019.

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  7. Ibid.

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  8. US SIF Foundation, 2018 Report on US sustainable, responsible and impact investing trends, 31 October 2018.

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  9. Ibid.

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  10. Ibid.

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  11. Petition to Securities and Exchange Commission, 1 October 2018.

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  12., “H.R. 4329: ESG Disclosure Simplification Act of 2019,” 7 January 2020.

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  13. Ibid.

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  14. White House, “Executive order on promoting energy infrastructure and economic growth,” 1 April 2019.

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  15. Deloitte, “Sustainable Finance: ESMA publishes technical advice on the integration of sustainability risks and factors in MiFID II, AIFMD and UCITS Directive,” 7 May 2019.

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  16. Response Global Media Ltd, “ESG: Do you or don’t you?,” 11 June 2019.

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  17. Deloitte, “Sustainable finance, EU keeps the lead: New guidelines on yearly disclosures, ESG taxonomy and expert reports published,” 20 June 2019.

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  18. GSIA, 2018 Global sustainable investment review.

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  19. Jacqueline Poh and Mariko Ishikawa, “China set to lead ESG disclosure to lure foreign investments,” Bloomberg, 20 June 2019.

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  20. Paul Davies, Bridget Reineking, and Andrew Westgate, “China mandates ESG disclosures for listed companies and bond issuers,” Latham & Watkins, 6 February 2018.

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  21. World Business Council for Sustainable Development, “New research on corporate reporting in Singapore: ESG disclosure helps identify risks and opportunities,” 15 October 2018.

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  22. Rebecca Elliott, “‘Sustainably fracked’: Shale producers seek a green label for their natural petrol,” Wall Street Journal, 22 August 2019.

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  23. Mozaffar Khan, “Corporate governance, ESG, and share returns around the world,” Financial Analysts Journal (2019): pp. 103–23,

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  24. Morgan Stanley and Bloomberg, “Sustainable investing goes mainstream,” 21 February 2019.

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  25. Ibid.

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  26. BNP Paribas, “The ESG Global Survey 2019.

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  27. Deutsche Bank, “Big data shakes up ESG investing,” 4 October 2018.

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  28. Axel Pierron, “ESG Data: Mainstream consumption, bigger spending,” Opimas, January 2019.

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  29. Ibid.

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  30. Truvalue Labs, “Amplified investment intelligence,” accessed 4 October 2019.

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  31. Arabesque website, accessed 31 January 2020.

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  32. Billy Nauman, “Artificial intelligence promises to enhance sustainable investing,” Financial Times, 20 August 2019.

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  33. MSCI, “Using alternative data to spot ESG risks,”, 6 September 2019.

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  34. Ibid.

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  35. Morgan Stanley and Bloomberg, “Sustainable investing goes mainstream.

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  36. BNP Paribas, “The ESG Global Survey 2019.

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  37. James Lord, “BlackRock adds US equity ETF to iShares ESG suite,” ETF Strategy, 13 May 2019.

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  38. Ginger Szala, “Dynasty adds Ethic ESG offerings to TAMP,” ThinkAdvisor, 10 July 2019.

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  39. Samuel Steinberger, “Robo adds Direct Indexing SMA Platform for advisors,” Wealth Management, 9 May 2019.

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  40. Jessica Pothering, “John Hancock rolls out COIN, a ‘conscious’ investment account for everyday investors,” Impact Alpha, 4 March 2019.

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  41. Morgan Stanley and Bloomberg, “Sustainable investing goes mainstream.

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The Centre wishes to thank the following Deloitte professionals for their support and contribution to this report: Sam Friedman, research leader, Insurance, Deloitte Services LP; Michelle Chodosh, senior manager, Deloitte Services LP; Patricia Danielecki, senior manager, chief of staff, Deloitte Center for Financial Services Deloitte Services LP; Jenny Lynch, senior manager, Deloitte & Touche LLP; Kathleen Pomento, senior manager, Deloitte Services LP, and Val Srinivas, senior manager, Deloitte Services LP.

Cover image by: Neil Webb

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