Navigating the ESG asset management landscape

Product demand for ESG remains high. Nearly all of the asset managers we spoke to offer ESG strategies to investors, and ESG was ranked first (in a tie with alternatives) as the strategy most in demand by investors. The larger the investor, the more likely that ESG will form a core part of their portfolio investment strategy. In this regard, ESG products are one of the top focus areas for more than half of institutional investors we spoke to.

In the recent rush by various market players to market and label products as ESG-aligned, many questions remain unresolved as to how ESG should be defined, measured, and compared. As money flows into products claiming to apply ESG criteria, investors and regulators are raising the alarm about the risks of “greenwashing.” The concern is that the underlying investments in these products may not in fact demonstrate environmental and social responsibility, or they may exaggerate their positive impacts.

As a result, North American securities regulators have issued draft rules and guidance on ESG-related product labeling and disclosures. In Canada, regulatory comments on share offering prospectuses over the last 12 months have overwhelmingly been related to ESG. Asset managers are feeling the pressure – from regulators and clients – to make sure ESG products have genuine environmental, social and governance descriptions and outcomes.

With the ESG market running ahead of regulation and legislation, however, asset managers in North America face some degree of risk without clear guidance on ESG measurability and comparability. Selling or marketing products that may not meet future mandated criteria could have disruptive effects for asset managers, whether from regulatory implications or client losses.

94% of the asset managers we consulted are seeing high investor demand for ESG products

Though the green transition is well underway, the reality is that we cannot shift to clean alternatives like renewable energy overnight. The imbalance in demand and supply for ESG-positive investment opportunities needs to be acknowledged and managed carefully. In fact, half of the asset managers we spoke to said the biggest challenge they faced this past year in offering ESG products was finding a strategy with enough investable opportunities in the market.

The original premise behind divestment from high carbon emitters was to make it more difficult and expensive for those companies to raise capital. However, the risk is that “dirty capital” from elsewhere in the globe will fill the gap, with far less investor and regulatory oversight of ongoing business practices and emissions.

An interesting trend is emerging along these lines. Some large institutional investors are establishing high carbon transition funds with significant allocations to carbon-intensive assets that have legitimate decarbonization strategies. Actively investing in the decarbonization of high intensity businesses rather than passively divesting presents two opportunities: it can enhance investment returns while demonstrating a meaningful contribution to real economy emission reductions.

We may see more asset allocation commitments like these in the coming months, as investors strive to meet their ESG commitments while delivering value to stakeholders in a challenging market.

We have not faced similar inflationary pressures and interest rate hikes since the 1970s, and these circumstances may be unfamiliar to a new generation of asset managers. These asset managers are at the same time grappling with the potential impact of global climate policies and challenges on future corporate valuations. If a firm is launching new ESG- and climate-themed products and funds, it will be important to understand how the underlying investments will react to higher interest rates and continued high inflation, and how the products may be evaluated in a rapidly evolving regulatory environment.

Wondering how to navigate the evolving ESG investment landscape? KPMG's Asset Management team is ready to provide ESG strategies, tax consultancy assistance, and regulatory analysis to help your business and investment portfolios stay competitive in the days ahead.