While ESG investing is on the rise, it’s mostly been for institutional clients. Is that poised to change anytime soon?
A lot has been made of the rise in ESG and impact investing, and there’s been plenty of discussion over whether the trend is going to last. Data seems to suggest that impact and ESG are only just starting to reach their potential, with hundreds of billions in AUM targeting impact funds. When trying to figure out how much more growth the sector is bound to receive, it’s important to look at the investors targeting this space, and if there are demographics that can still be brought into the fold.
Who’s investing in ESG?
At a November 2021 JTC webinar, one of the most intriguing topics for participants was a breakdown of who is actually investing in ESG. While skeptics may dismiss impact investments as charity projects designed for wealthy individuals dreaming of saving the planet, that hasn’t proven to be the case. For the most part, ESG investments have been dominated by large funds, not individuals.
According to the 2020 Report on US Sustainable and Impact Investing Trends from the US SIF Foundation, of the more than $16 trillion in assets to which money managers apply ESG criteria, 72% were managed on behalf of institutional investors, compared to 28% for individual investors.
Why is that? There are a few reasons, and understanding them can clue us in on whether or not we can expect more individual investors to put their money into ESG-focused investments in the future.
Why institutional investors dominate ESG
One reason institutional investors have more readily adopted ESG is because since institutional investors work with large funds managed by some of the industry’s leading managers, they’re ahead of the game when it comes to insight into industry trends. We’ve discussed before how impact investments are proving to provide returns that match or exceed traditional investments, so managers working with institutional clients are surely recommending these products as sound investments.
If the only thing keeping individuals from taking part in this growing sector were a lack of awareness, it would be expected that financial advisers would follow suit and start recommending ESG to their affluent clients, resulting in a wave of individual investment. However, there’s another aspect to consider, one that institutional investors are better equipped to take on.
ESG investments often have complex reporting requirements and rapidly-changing compliance standards depending on where the fund is located. Individuals may not want to deal with this type of complexity, whereas institutional investors working with managers experienced in these reporting requirements would be less skittish.
While the above are both considerations for investors, the biggest thing keeping individuals from investing in ESG may simply be a lack of understanding about which investments to select. In a 2021 EY survey, when managers were asked to name the greatest obstacles to launching ESG alternative investment products, the most common response was “Lack of standardized methodologies to rate ESG effectiveness.”
While it’s easy to understand whether an investment product has produced competitive returns, without industry-wide standards for rating effectiveness in all areas of ESG, investors can’t be confident their investments are actually making a positive difference. That’s why JTC is a leader in the push for accurate impact reporting and has worked on methodologies to evaluate impact across different kinds of investments: so funds can demonstrate the effectiveness of their investments from both a financial standpoint and an impact standpoint.
When will individual investors catch up to institutional investors on ESG?
Since investors are seeing tremendous gains from impact investments, financial advisers would be remiss in not recommending vehicles like Opportunity Zones that create an impact while also providing financial incentive. Already, it appears this is taking place, as more financial advisers are recommending ESG products than ever before, and in greater allocation.
The other big key to the ESG revolution is the coming of age of affluent individuals from Generation X and Millennials, who not only have a desire to make an impact, but an expectation that their investments should be able to succeed both financially and in terms of responsibility to society and the planet. As EY put it, while “a lack of data standards around ESG remains at the heart of many managers’ challenges with adoption, managers who have not yet increased integration of ESG risks and sustainable investments across their corporate policies and product mix are at risk of losing investor interest and capital.”
Leading the way on Impact & ESG
In the near future, as young affluent individuals enter the investing world and financial advisers continue to recommend impact investments, institutional and private clients will be seeking ESG in greater numbers, meaning it is poised to continue to rise in demand.
To take advantage of this growing demand, fund managers need to be able to demonstrate that their investments provide competitive returns when compared to investments across the industry as a whole, that they’re capable of handling the complex reporting and compliance requirements of ESG investments, and that they’re incorporating ESG practices into their own businesses; but most of all, they’ll have to prove that their impact is real.
Because ESG involves heavy reporting requirements and a need to demonstrate how your impact is outshining others, JTC offers a full suite of ESG fund administration capabilities, including real-time impact tracking and reporting. JTC was awarded the “Fund Administration: ESG” prize at the 2021 Drawdown Awards because of its industry-leading technology, practices and solutions for ESG and impact. No matter where you are on your impact journey, we can help you provide more for your investors so they can feel confident in your commitment to ESG.