ESG outlook: From moral imperatives to financial materiality

We believe the investment world is poised to realign itself with the foundational principles of responsible investing, emphasizing financial materiality and evidence-based practices. This shift is propelled by a global acknowledgment of the intricate connections between geopolitical events and domestic politics, underscoring the importance of adhering to investment fundamentals.

The PRI in PERSON conference in Toronto in October 2024, which attracted over 2,100 professionals, served as a testament to this pivot. Discussions signaled a shift from moral imperatives to practicalities, reflecting a growing pragmatism in the industry that is heavily influenced by U.S. participants.

At Janus Henderson, these principles have always been at the forefront of our responsible investing activities. We believe a thoughtful, practical, research-driven, and forward-looking approach to ESG integration not only supports investment managers’ fiduciary duty but can also be beneficial in navigating geopolitical developments. In addition to tense international relations, investors must continue to navigate climate change implications, energy security, and supply chain issues. The role of geopolitics in ESG is becoming more prominent, with significant investments in clean energy by China and Japan’s Green Transformation plan as prime examples.

Large-scale issues, such as decarbonizing the electrical grid, require regulatory oversight and legislative incentives, underscoring the need for both systemic policy engagement and company-specific dialogue. This approach is vital as investors weigh the financially material outcomes of their decisions in 2025 and beyond.

DEI initiatives shift, but persist

Over the last decade DEI initiatives have become central to strategic discussions within organizations against a shifting political backdrop. And despite mixed opinions as to their effectiveness in shaping workplace culture and achieving concrete results, the commitment to fostering equitable and inclusive workplaces remains unwavering.

That said, some companies have removed or are rethinking their DEI programs, with a shift toward emphasizing concepts like belonging and inclusion and moving beyond mere representation as a success metric. This transition underscores a growing expectation for DEI efforts to yield measurable business benefits. These can include innovation, employee retention, and customer satisfaction. However, focusing solely on quantifiable results may overlook broader cultural objectives and may not address systemic barriers.

Regulatory and legal challenges have also emerged, especially concerning race- or gender-based hiring practices, prompting increased scrutiny of DEI strategies. Further, the definition of DEI is expanding beyond traditional categories to embrace mental health, neurodiversity, and socio-economic status, and reflecting a more comprehensive understanding of diversity.

Approaches to implementation are also changing, with a trend toward integrating DEI responsibilities across various departments rather than centralizing them within specific DEI roles or departments. This approach aims to embed DEI principles more deeply into the organizational fabric to align with broader HR, management, and leadership practices.

Despite challenges and change, we believe the fundamental objectives of DEI – to create a fair environment where all employees can thrive – remain crucial for organizations. This is evident at Janus Henderson, where DEI is part of our core values and guides our commitment to emphasizing the importance of diverse thinking, authenticity, and inclusive perspectives in helping us exceed our clients’ expectations.

Aggregating and integrating ESG data

Considering ESG risks and opportunities throughout the investment process can lead to better outcomes for investors. However, the quantification of these risks and opportunities has always presented challenges. Historically, corporate reporting on ESG issues has been spotty, qualitative, and/or not standardized across companies.

Fortunately, the tides are beginning to shift. Financially oriented ESG standard-setters are defining best practices, much to the delight of regulators worldwide. This regulatory support is paving the way for investors to access a wealth of ESG data from corporations, though the aggregation of this data and its integration into the investment decision-making process present unique challenges.

To improve data coverage for portfolios, investment managers often use multiple third-party ESG data providers or fill gaps with proprietary data. Having a robust taxonomy to organize this data enables critical downstream activities, including a central calculation engine and data visualization tools.

Strong data practices enable a consistent, methodical approach. It is imperative that the portfolio-level metrics investment managers are looking at align with those being assessed across an organization – for example, by risk management teams measuring financial risk by compliance departments maintaining exclusions or binding investment criteria, and by client reporting teams in developing regulatory and non-regulatory reports. Getting this approach right allows investment managers to take a stance on areas of debate within the industry, including whether short positions should offset long positions, or how cash or derivatives are treated.

To support this approach, we’ve developed a proprietary ESG data tool called “ESG Explore”. This tool offers in-depth data insights at both the portfolio and issuer levels, featuring modules on ESG ratings, climate metrics, involvement in controversial businesses, proprietary engagement data, and regulatory indicators, with further enhancements on the horizon.

Even if global standard-setters continue to consolidate and reporting best practices are adopted by regulators, the ESG-related data investment managers can expect to receive from corporations will require processing and cleanup. This continues to be a key area of focus for us in 2025 so we can surface data for our investment teams and clients in a useful way.

Responsible AI takes center stage

AI is making remarkable strides across a spectrum of key intelligence capabilities, including speech recognition, image recognition, reading comprehension, language understanding, and predictive reasoning. These advancements, which are now achieving or even surpassing human performance levels, have resulted in an investment goldrush, with an estimated US$1 trillion expected to be invested into AI infrastructure over the next few years.¹

But as generative AI (Gen AI) applications have been rolled out to companies and consumers, fears have spread over misuse and safety. Errors (or so-called hallucinations) in Gen AI models, bias in results, concerns over intellectual property theft, environmental impact, and even existential threats posed by artificial general intelligence (AGI) are being actively debated.

Given these concerns, AI regulation is coming, most notably with the EU AI Act that came into force on August 1, 2024, but also with new and proposed regulations at the country level and at the state level in the U.S.. At the same time, countries are competing to attract AI investment and promote innovation – a tricky balancing act.

From a responsible investment perspective, AI represents a significant challenge. AI is not inherently good or bad; it offers potentially significant benefits to humanity but is also open to misuse.

AI’s advancements hold promise for significantly enhancing human health through improved diagnostic and health monitoring tools, assuming privacy concerns are addressed. While AI has the capacity to automate repetitive tasks and potentially enrich certain job roles, it also raises concerns about job displacement. Further, AI could be instrumental in addressing environmental challenges and reducing carbon emissions, though its current energy consumption patterns may contribute to increased emissions.

A thoughtful approach to responsible AI is required. There is no simple “off-the-shelf” framework to be applied, and one-dimensional scoring models fail to capture the emerging complexity. Effective regulation is essential, but investor stewardship and engagement are also crucial to ensuring we capture the upside and limit the downside of this revolutionary technology.

Navigating challenges for a brighter future

In 2025, we expect the responsible investing landscape will undergo a significant shift toward its core fundamentals, with a pronounced emphasis on financial materiality, evidence-based practices, and a pragmatic approach to ESG integration. This marks a pivotal moment where the integration of comprehensive ESG data, the responsible application of AI, and the evolution of DEI initiatives become central themes in corporate behavior and, therefore, investment strategies. These changes reflect a deeper recognition of the complexities of geopolitical developments, technological advancements, and social dynamics, urging investors to adopt more nuanced, informed, and ethical approaches.

As the industry moves forward, the ability to navigate these shifts – by leveraging robust data practices, engaging responsibly with AI, and embedding inclusive DEI principles – will be crucial to achieving sustainable investment outcomes. This evolving landscape presents both challenges and opportunities, emphasising the need for investors to stay informed, adaptable, and committed to responsible investment principles that align with long-term value creation.