The growing acceptance of environmental, social and governance practices, or ESG, in corporate boardrooms is happening sooner than many companies expected.
And it is being felt by asset managers in the middle market, who are dealing with a client base that is demanding accountability on their investments’ impact when it comes to ESG. This means that asset managers will need to shift strategically and reinvent the way they deploy capital while also building innovative partnerships to improve business results.
“Institutional investors must carefully evaluate their holdings to ensure that all positions held align to the missions and values of the broader investment thesis,” said Anthony DeCandido, a partner at RSM who specializes in ESG.
A changing landscape
Consider just how dramatically the landscape has shifted in recent years.
The Business Roundtable announced a series of initiatives "to advance racial equity and justice." These initiatives include examining hiring practices, reviewing compensation and increasing transparency regarding the racial makeup of their leadership and workforce. They followed an announcement by the group in September calling for “a well-designed market-based mechanism and other supporting policies” to address climate change.
And before that, in perhaps the most significant shift, the Business Roundtable redeﬁned the purpose of a corporation from simply making proﬁts for shareholders to beneﬁting multiple stakeholders, including customers, employees, suppliers, communities and shareholders.
The times are indeed changing, and already senior executives of middle market businesses are keenly aware of the imperative. According to a survey taken in 2019 that was part of the proprietary RSM US Middle Market Business Index, roughly 90% of middle market business leaders said they believe ESG is important, an overwhelming percentage that has almost certainly gained traction since then, given the social unrest and prominent natural disasters of recent months.
The accountability question
But how can investors be sure that their money is being used in the way they intended? And how can asset managers know?
This challenge offers one of the biggest rewards. Companies that can quantify the impact of environmentally friendly investments will have an advantage. There are a number of methods for accreditation, DeCandido said, but none has yet emerged as the industry standard.
It’s all part of the challenge for asset managers, particularly those in the middle market, where resources can be limited. RSM has identified three priorities that can help guide managers’ decisions in the ESG arena:
- Educate all stakeholders on how ESG behaviors influence better business results. There remains significant confusion in the middle market around how ESG behaviors drive superior financial and nonfinancial results. It need not be one without the other. This includes which reporting frameworks and key performance indicators are most relevant to a company, and can be determined only by a company’s unique missions and values, the industry landscape and which inputs are believed to be most material to the organization
- Simplify reporting and communications. Comparability is important because what matters to one company may not be as relevant to another. At the same time, there are ESG essentials that all companies should consider. Reporting standardization could help organizations prepare their initial ESG assessment of business risks and opportunities and then communicate these results to its stakeholders
- Evaluate and analyze key performance indicators that connect strategy and impact. Data and technology will enable deeper company analysis and provide the kind of benchmarking needed for stakeholders to make informed decisions. Companies will struggle between issues of data abundance versus data unavailability, financial data versus nonfinancial data, and alternative data versus traditional data. Converging these data sets will be important to link business behaviors to intended outcomes.
Is there a tradeoff?
Underlying ESG investing is an inherent tension between the actual benefits of applying these strategies and the financial cost needed to execute them. Would a manager be willing to forfeit a few points of financial returns for the sake of doing good for society?
Many proponents of ESG investing argue that this trade-off is a false choice. They may argue that an investor can continue to earn a healthy return while still benefiting society, pointing to wind power investments as just one example.
What is clear, though, is that as interest in ESG rises, the dollars are following, DeCandido said. And asset managers are increasingly leaving money on the table if they ignore it.
“Investors are pouring money into the sector,” he said. “Many managers can point to successes and demonstrate the positive impact their investments are having—and that only attracts more investment.”