ESG will be a Normal Part of Fiduciary Duty

Over several decades, environmental, social and governance (ESG) considerations have staked a real claim in the contemporary definition of fiduciary duty. Many countries are reviewing the scope of fiduciary duty with an eye to ESG requirements. For investors, the long-term implications are clear; ESG will become a fully accepted part of fiduciary duty. Sooner rather than later, trustees, agents and advisors will be called upon to take a broader set of considerations including ESG factors into account.

Climate Change will be Mainstream

In light of COP21 – the most recent annual Conference of Parties (COP) – and ahead of COP22’s focus on collaboration against climate change, it would be difficult to deny that the transition to a low-carbon economy is on the cards. Stranded fossil fuel assets have gained attention and it is expected that divestment from carbon-intensive sectors and companies will accelerate. More companies will aim to achieve carbon neutrality as countries work to lower emissions. Over time, financial markets’ inclusion of environmental considerations will become standard practice.

From Responsible to Impact Investments

Fifteen years ago, a clear divide separated corporate governance teams from the environmental and social specialists of what was then called socially responsible investment (SRI) – and to some extent both sides were pitted against each other. Eventually, the two came together, rallying under the ESG banner and giving a strong boost to the field. It’s fair to say that the impact and ESG groups will also merge, forming a single core competence that extends the scope of RI.

The Successful Approach will be ‘All-in’

In the early days of ethical investing, much of what was done remained niche and subjective as investors applied their own values to their portfolios. As the field evolved from ethical to SRI to RI, terms, metrics and best practices all came to the fore. That early subjectivity will become a distant memory for investors pursuing a responsible agenda and for mainstream investors alike. Picking and choosing a set of factors or preferences will no longer be an option.

All ESG factors must be simultaneously considered. Look no further than the recent example of Tesla, the premium electric vehicle manufacturer, whose subcontractor reputedly paid workers less than the legal minimum wage to build a new paint shop in one of its factories. This illustrates the importance of supply chain management and potential reputation risks, even for businesses with reputational halos. In order to build a successful portfolio, investors will need to lock in the key remunerated risks and mitigate all others.

Significant Risks Will Cut Across Asset Classes

In the past, we have seen single environmental, social or governance tail events that make headlines and cost investors significant sums à la BP’s Deepwater Horizon, the Madoff scandal and the Volkswagen emissions debacle. Other larger topics lurk in the future that are not limited to a single company or sector. In April 2016, a coalition of investors challenged the ‘systemic overuse’ of antibiotics in livestock production, for example. This is a case where a material ESG issue has the potential to affect different sectors. It would be reasonable to expect similarly far-reaching issues to surface in the future.

Technology will be a Real Test of ESG in Practice

Robotics and artificial intelligence offer new technological frontiers and productivity improvements, yet automation in the workplace may displace large portions of the workforce. According to Boston Consulting Group¹, 25% of all manufacturing tasks performed in 2025 will be done by robots. ESG considerations could provide a framework for mitigating some of the most harmful consequences of job loss from technological advancement. Creative, holistic solutions will be required to promote inclusive development.

There will be Risks and Opportunities

It is becoming increasingly clear that consumers, regulators and politicians will hold those perceived as not paying their ‘fair share’ to society accountable, as demonstrated by the recent consumer backlash against Starbucks for example for a relatively low UK tax bill that led to a decline in sales. Such cases suggest that companies will face pressures to actively contribute to a fair and sustainable system in the years ahead. On the flip side, funding the sustainable future will open new investment opportunities, including impact investments and green bonds.

Source: AXA Investment Mangers Via Morningstar. 01/11/2016