The consideration of environmental, social and governance issues into institutional investment will be one of six major macro trends over the next five years, due to sustainable performance influences and desirability, according to a major study by Watson Wyatt, the investment consultant. Its Defining Moments report examines current industry trends in order to predict the future shape of institutional investment.
The study said the growth of ESG investing would be predicated on four major trends: demand for big institutional funds to apply responsible investing principles, sustainability and climate change as mainstream or specialised propositions, the impact of politically motivated activism, and responsible investment becoming more personalised through defined contribution pensions saving. The emergence of climate change as an issue of major societal importance could be “the catalyst for change,” it said.
It identified several ways in which the ESG trend would manifest itself. The first, it said, would be greater pension fund activism in challenging the boards of companies they invest in over strategy and governance questions inan attempt to “improve shareholder wealth rather than just passively accepting sustained mediocrity.”
A second area of expanded activism, it said, could involve “economically targeted investments” (ETI) intended to improve the economic well-being of a geographical region and its residents.
The third and most controversial area of activism, it said, regarded increasing investment decisions based on social, moral or political beliefs.
Watson Wyatt said: “Prospectively, we can expect to see increasing levels of activism as a controversial complement to economic investment.”
Notably, the Watson Wyatt report outlines serious concerns about institutional investors failing to be long-term in their investment outlook. It claims short-term investment thinking is making the delivery of investment performance more difficult because of rising costs for financial products: “This prevents funds attaining realistic long-term goals. We believe there are real opportunities for investors to exploit a longer time horizon, but are also cognisant of the challenges associated with it.”
Similarly, the reports strongly criticises the sub-prime crisis as a ‘systemic issue’ based on a vicious circle of short-termism, disintermediation of product sellers from risk and flawed and excessive incentive structures that pushed market participants to “ensure the system remains prone to periodic crises”. The report says: “The problem resides in excessive competition, complexity and compensation.”It said investment borrowing or ‘leverage’ had also become the “master as opposed to the servant” for investors because of over competition for 10%+ returns. Another major trend observed by the report is increasing concern amongst investment professionals that defined contribution (DC) pension plans will not be able to meet future pension payments without radical transformation.