Pension Funds Letter 6 - Embracing the full potential of ESG investing

From a late-cycle investment tactic to a strategic long-term approach

The recent financial market conditions, marked by increased volatility and cumulative rising rates in the US, clearly confirm the end-cycle momentum. Facing this uncertain and challenging environment, asset owners are progressively turning off the risk engine. In that context, ESG1 investing should play an increasing role in Pension Funds’ allocations, as it provides interesting diversification features as well as hedging properties against fat-tail risks, particularly hard to detect in the current market environment.

Beyond economic and financial cycles, ESG as a long-term investment theme has become mainstream and institutional investors such as Pension Funds cannot ignore it anymore. ESG being multi-dimensional, they will need to adopt a holistic framework to make the most out of it. When investing through the ESG lens, Pension Funds should not only take into account performance, i.e. how to get exposure to long-term growth trends embedded in ESG, but also risk, i.e. how to use ESG as a hedge against long-term risks, and last but not least, engagement, i.e. how to finance trends essential to the future of our planet.

From a risk hedge to a performance driver

While the use of ESG strategies as a hedge against long-term risks such as climate risk is undeniable, the contribution of ESG investing to better performances in the long run is harder to prove by research academics. Findings are subject to interpretations, depending on the ESG scope (E, S or G), the methodology, the selected regions and the time periods. However, our latest study on ESG equities tends to demonstrate that best-in-class ESG portfolios outperform worst-in-class ones since 2014, particularly in the Eurozone and North America. The persistence of an ESG reward over time and across regions also indicates that ESG is moving from an alpha source of performance to a beta one, becoming a performance factor to be integrated in a multi-factor approach.

From mainstream to innovation

Beyond performance and risk, ESG is also a matter of engagement, paving the way asset owners can contribute to build a better future for the next generations by financing the adequate sectors. Impact investing represents a good way for Pension Funds to achieve this goal and to get a measurable impact of their invested assets. In that respect, the integration of the UN SDGs2 framework into an impact investing approach is very innovative and illustrates how an asset owner can align his investment goals with the societal trends that will shape tomorrow’s world. The innovation road on ESG investing is still very long to go. Partnership initiatives between Pension Funds and Asset Managers are key to explore these new territories and discover new investment opportunities along the way.

To find out more, download the full letter

___________________

_{1. Environmental, Social and Governance}

_{2. United Nations Sustainable Development Goals}