Institutional investors are demanding that asset managers provide greater transparency in their reporting on ESG investments, according to Cerulli Associates, which calls the trend “one of the most significant changes in responsible investing in recent years.”
Stakeholders, who also include regulators, clients and the public, want clear and comprehensive reports on environmental, social and governance-related activities, the latest Cerulli Edge — U.S. Institutional Edition reports.
Cerulli states that 58% of institutional investors require or plan to require asset managers to give them portfolio-level exposure to financially material ESG risks, in addition to impact and thematic reporting. Currently, 23% of asset owners require their asset managers to report on ESG-related engagement activities, and 22% say they will require it in the next two years.
“This demand for transparency reflects the broader push for responsible and accountable business practices across industries,” says Cerulli analyst Gloria Pais in a news release. “Institutional investors want to ensure ESG considerations are not just a passing trend, but a fundamental part of the investment process. As such, asset managers must step up their reporting efforts to meet the expectations of asset owners and remain competitive in the evolving market,” she adds.
Challenges to ESG Reporting
Cerulli says meeting the new requirements may be a challenge, largely because there are no standardized reporting guidelines for ESG metrics. Asset managers may have difficulty defining ESG risk and impact consistently across different sectors and industries. That makes it difficult for asset owners to compare performance across their portfolios and make informed decisions, Cerulli says.
The industry is working to standardize ESG reporting terminology and measurement frameworks but faces hurdles. According to the report, 38% of asset owners say defining ESG boundaries is a key challenge, especially when differentiating between ESG and impact investing.
Asset managers involved with responsible investing programs need to invest in robust reporting systems that meet these expectations, Cerulli says.
“Comprehensive, standardized reports on ESG risks and impacts can help asset managers demonstrate their commitment to responsible investing and attract more institutional clients,” Pais says. “Furthermore, asset managers at the crossroads of evolving market demands should focus on integrating ESG considerations into their investment processes. These steps will help asset managers remain competitive and align with the values of their institutional clients,” she concludes.
Trends Pro and Con
Cerulli reports that responsible investing faces increasing political headwinds, causing some institutional investors to drop such investments. The pace of new responsible investing has slowed, a record number of recently listed fund products have closed, and among funds that use or have used the ESG label, 10% have dropped it, according to the report. Among asset owners, 10% have scaled back on incorporating ESG factors into their investment strategies, mostly in response to political pushback.
However, the trend toward responsible investing and diversity in investment management is still gaining momentum, the authors state. Over the past five years, 94% of institutions that invest in responsible investing products have maintained or increased those allocations. Most institutions plan to increase or maintain such investments. However, some plan to reduce allocations to screening (23%) and ESG-focused products (22%).
Exclusions and Inclusions
Negative exclusionary screening — avoiding investment in companies associated with products considered undesirable — is used by 45% of institutions. Top screens include:
Coal 61%
Fossil fuels 57%
Private prisons 34%
Opioids-related holdings 31%
Tobacco 61%
Firearms/weapons 58%
Gambling 46%
Adult entertainment 46%
Alcohol 38%
Areas of responsible investing favored by institutions include
Clean technology and renewable energy 59%
Climate change/carbon reduction 52%
Environmental sector 45%
Clean water/water scarcity 42%
Healthcare 41%
Diversity & inclusion 39%
Sustainable natural resources/agriculture 38%
Diversified ESG products 29%
Education 29%
Housing/community development 28%
Waste management 23%
Biodiversity conservation 11%
ESG Backlash
Shifting political winds are playing a significant role in the responsible investing landscape. About 10% of asset owners have scaled back ESG considerations in their investment decisions. According Cerulli this is mainly due to political pushback, as more Republican-leaning legislatures have passed laws restricting the use of ESG factors in investment decisions.
Additionally, 34% of institutions that have reduced ESG investing say the primary deterrent was the time-consuming and costly process of responding to backlash. Also among those that have scaled back, 28% say they lost confidence in the merits of ESG, 24% cite litigation fears, and 14% report external pressure from stakeholders.
External Advisors Gain Prominence
More asset owners are using external advisors such as investment consultants and outsourced chief investment offices (OCIOs) to address the complexities of ESG reporting and investment management, Cerulli reports.
Such personnel are instrumental in helping asset owners respond to the ongoing ESG backlash, communicating how responsible investing can mitigate risks such as climate change, reputational damage, and regulatory turmoil, according to the report.
