Talk to any fund house of note today, and one of the first things they raise in conversation is their commitment to ESG.

Environmental, social and governance-friendly investments are fast becoming go-to product solutions. This in large part down to marketing – it’s good business to be a caring asset manager that can also offer good returns, instead of just the latter.

The emphasis is also a recognition of the way the wind is blowing. Governments and regulators across the world are pushing stewardship responsibilities and rules for companies to declare their environmental standards, both in their own businesses and, increasingly, in their supply lines.

Asset owners are taking note too. Japan’s Government Pension Investment Fund, New Zealand Super and Australia’s Hesta were some early adopters but now the likes of National Pension Service of Korea, China’s Ping An Insurance, the Hong Kong Monetary Authority and GIC of Singapore are pushing forward their respective commitments to responsible investing too. ESG has gone mainstream.

By and large, that is a good thing. For decades major investors were able to hide behind claims of fiduciary responsibility to avoid considering the impact of investments into fossil fuel companies or those with dodgy ethical standards. Several countries in Asia, possesses companies and governments with questionable commitments to the equal rule of law, corporate transparency and minority shareholder rights.

Combating this requires both increased application of the rule of law and a willingness by major investors to ask questions and, where necessary, divest.

ACTIONS, NOT WORDS

But effective ESG investing also requires genuine dedication, not just chest-thumping.

The rapid proliferation of ESG funds across the region may well be due, at least in part, to fund managers looking to offer feel-good credentials to investors who want to be seen as taking worthy aims seriously. In other words, both sides focus more on the appearance of doing the right thing rather than genuinely attempting to do so.

It’s not simply greenwashing, or funds and investee companies that only pretend they are committed to environmental standards, although that represents one danger. Major companies like Ping An Insurance are coming up with analysis tools to try and better identify such actions. That should help to weed out bad actors.

The more difficult challenge to address will be to encourage institutional investors, large and small, to think through how they want to invest sustainably, what particular goals they most wish to achieve, and define what success looks like. Do they focus on minimising carbon emissions? Focus more on gender equality and employee rights? Emphasise information disclosure and respect for minority shareholders?

For asset owners just starting to engage with ESG, covering all the disparate areas it encompasses will be hard, especially over multiple asset classes. Setting realistic goals will be very important.  

Fail to do this, and asset owners may have end up investing into a set of individually ESG-friendly funds that, when combined, lack a particular focus. It would also make it harder to identify the best partners to meet their responsible investing priorities.

Worse, the funds they pick may well differ on how they apply ESG measuring, potentially diminishing or even cancelling each other's effectiveness out. 

Investors should ideally also commit to the concept of ESG investing, not just view it as a helpful new investing gauge. The latter approach is understandably tempting; several research reports surveys over the past year have suggested that ESG-affiliated equity funds have performed better than vanilla peers during 2020.

It is possible that ESG-compliant products are rapidly sold on the back of sudden investor enthusiasm that end up disappointing amid broader market rallies in 2021. Were that to occur, today’s compelling rationale for ESG funds could become seen as an irrational fad in six months - damaging their longer term credibility.

RISK, NOT REWARD

That is why it is so important that asset owners seriously consider their longer lasting appeal and how best to utilise them.

Put together sensibly, ESG funds should generally do better than alternatives because they place serious emphasis on corporate transparency, governance standards, employee rights – and the vulnerability of companies to rising environmental standards and penalties for breaking them. But this isn’t guaranteed every year; such outperformance may take years to shine.

Viewed most simply, ESG is a risk management tool – one of the risks of which happens to be global environmental catastrophe. But for all the impressive performance of ESG funds in 2020, it might be wisest for asset owners to focus on the perspective of risk instead.

Returns come and go. Risk never disappears.