Tim Gerrard, Portfolio Manager in the Janus Henderson Global Natural Resources team, comments on the rapid rise of ESG and the fundamental change it is having on companies and investments.

What a difference a year makes. Brexit may not have progressed far, but in the 12 months since my 2018 trip to London, it’s clear that environmental, social and governance (ESG) issues have taken centre stage. Further to my own impressions, the perceived fundamental shift in thinking is also backed by a recent survey of 600 funds management groups controlling US$20 trillion. They predict that ESG metrics will be more important than traditional financial measures within five years^1..

Clients demand sustainability

At UBS’ recent ESG and Sustainability Symposium in London, the investment bank said its two most important long-term considerations are trends relating to China and sustainability/ESG. UBS noted that its clients are amazed at the speed of public engagement as societal expectations have changed markedly. September’s global student climate strike and the 11,000 odd scientists that declared a climate emergency in November reflect the tide of public sentiment.

Against that backdrop, it isn’t surprising investors want portfolios that reflect their values and a dialogue that is about more than just the financials. Increasing pressure on corporations to plan for climate change appears inevitable and significant time and money will be required to embed ESG considerations into operations.

Companies under pressure

Boards are also well aware of the expectation that they must act now. Companies have a fiduciary duty to measure the risks of climate change and its materiality to their business. They are also now finding themselves overwhelmed by investor requests for an ever-expanding range of information. While the Task Force on Climate-related Financial Disclosures (TCFD) framework may be compulsory in Europe by 2022, there is still a long way to go before reporting on ESG criteria is standardised.

At the very least, companies will need to provide a plan that aligns with the Paris Agreement. Green finance will likely also play a role as it facilitates companies highlighting carbon mitigation projects with an audited trail.

Financial markets no longer fit for purpose

There is a clear consensus that there are massive risks to financial markets from climate change. Investment banks like UBS, therefore, plan to develop futures products and indices to help mitigate climate change risk.

In fact, entirely new infrastructure is required. Comprehensive ESG service providers, similar to credit rating agencies, will likely emerge and there will be a proliferation of data, including satellite imagery, to support in-depth analysis of climate change, seasonality and volatility.

Implications and opportunities for fund managers

Best-in-class fund managers apply an ESG lens as part of their investment evaluation and decision-making process. So, regardless of the strength of their cash flow and dividends, companies that don’t take their ESG responsibilities seriously will eventually be excluded from indices and a majority of portfolios. We expect the popularity of climate-aware funds will grow among passive investors as they will be under-weight the highest risk sectors. Active fund managers will have to truly engage with companies about both risk-mitigation strategies and the opportunities that will emerge.

By embedding ESG considerations into the investment process, engaging companies about climate risk mitigation and strategies for carbon abatement, the funds management industry can make a positive impact for society.

In the Janus Henderson Global Natural Resources Team, we actively engage with companies, including some of the sector’s biggest names. We use our shareholder votes and opportunities to meet with company leadership to raise ESG-related matters. Our seven-stage investment process takes ESG factors into account and we will exit positions where we feel companies aren’t doing enough to improve their practices.

Fund managers that invest responsibly can be a powerful force in making the world a better place, ensuring that future generations won’t be disadvantaged by the actions of the present generation.

1. ‘ESG – Do you or Don’t you?’ UBS, Responsible Investor Research. 11 June 2019. https://www.esg-data.com/product-page/ESG-DYDY-organisation