Explore Our investment Outlook
ESG Trends
Two Questions as We Look Ahead
ESG Regulations: Are the Europeans Coming?
Asset managers with exposure to the European Union must comply with the new Sustainable Finance Disclosure Regulation (SFDR) and associated EU Taxonomy in 2021.1 These regulations will likely have a positive effect by making greenwashing more difficult.
Greater transparency and clarity will raise barriers to entry, so it will be harder for asset managers to stick ESG labels on their investment products. Such cleanup (pun intended) is to be welcomed because it arguably gives competitive advantages to asset managers with stronger ESG capabilities.
Whether ESG regulations in Europe reverberate globally depends on the regional context and the policy priorities of respective countries. The imperative for addressing ESG puffery in fund disclosures and promoting climate-conscious capital allocations is gaining consensus in the investor community. For example, the U.S. Securities and Exchange Commission recently established a Climate and ESG Task Force, and Japan’s Financial Services Agency reviewed new rules for mutual funds to protect investors from possible ESG washing.2 We believe the U.S., as well as some east Asian and Australasian markets, will likely look at western Europe for guidance on ESG investing best practices.
Overall, as we said in 2020, investors will increasingly demand clear, verifiable evidence that managers have fully integrated ESG considerations in their investment processes.3
Will There Be a Dotcom-like ESG Bubble?
We believe ESG momentum will continue as trends become ingrained with economic realities. While there’s an argument to make around ESG issues being “asset class agnostic,” it’s harder to make the same argument about implementation of ESG at the individual strategy level.
Time horizon, turnover, risk appetite and investable universe are important characteristics to consider in ESG capital allocations. Some strategies, by nature of their design and alpha objectives, may be forced out of the scope of ESG regulatory schemes. This increases the risk of an overcrowded ESG trade (i.e., overpricing) as managers create similar products and own the same securities.
As ESG demand grows, investors should be mindful of the potential clustering risk around the ESG trade. Asset managers should redouble efforts to be creative in unearthing ESG rising stars (i.e., issuers in earlier stages of business inflection) at the onset of their ESG disclosure journeys or on the verge of improvement following business misconduct controversies.
1 Regulation (EU) 2019/2088 of the European Parliament and of the Council of 27 November 2019 on sustainability-related disclosures in the financial services sector, EUR-Lex, December 7, 2020.
2 Takasha Nakamichi and Takako Taniguchi, “A $9 Billion Mizuho Fund Sparks Review of Japan ESG Labels,” Bloomberg, March 3, 2021.
3 Guillaume Mascotto, “ESG Outlook: Five Key Trends Are Driving Momentum in 2020,” American Century Investments, March 2020.
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References to specific securities are for illustrative purposes only, and are not intended as recommendations to purchase or sell securities. Opinions and estimates offered constitute our judgment and, along with other portfolio data, are subject to change without notice.
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International investing involves special risk considerations, including economic and political conditions, inflation rates and currency fluctuations.
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Alternative mutual funds that hold a variety of non-traditional investments also often employ more complex trading strategies than traditional mutual funds. Each of these different alternative asset classes and investment strategies have unique risks making them more suitable for investors with an above average tolerance for risk.
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