Sustainable investing now appears an inexorable trend as more investors see the need to incorporate environmental, social, and governance (ESG) principles into their decision-making process. And while ESG investing is still being led by the largest asset owners such as state pension funds, sovereign wealth funds, and insurers, they are expected to influence the behaviour of smaller institutional investors in the coming years, according to research and consulting firm Cerulli Associates.

A recent survey by Cerulli in Asia finds that the majority of respondents have adopted ESG criteria for their investments. About two-thirds of asset owners also said their firms have an investment policy statement specifying ESG priorities and principles.

Large institutional investors, especially in Australia and Hong Kong, are moving towards systematically incorporating ESG factors in assessing risks and opportunities during financial analysis, the survey reveals. Australian investors are advanced in their integration of ESG principles in their investment portfolios, with ESG integration being the most widely employed method, followed by active ownership.

As asset owners increasingly align their portfolios with ESG standards, managers will need to meet their growing expectations, says Cerulli. Its survey finds that 48% of asset owners have built ESG teams, while almost three-quarters of them look for external managers’ expertise to acquire ESG knowledge. Some 70% of pension plans are looking to build their capabilities over the next three years, indicating huge potential opportunities for managers.

When outsourcing portfolio management to external managers, around two-thirds of asset owners in the survey say that integration of ESG factors into investment processes is currently not mandatory. Also, Cerulli’s discussions with industry players show that mid- and small-sized institutions have been slow to embrace the concept. Still, a significant majority of the survey respondents believe that ESG considerations are either “very important” or “moderately important” when hiring managers. Close to half (48%) of asset owners think the ESG aspect is “very important” when hiring managers, with another 48% saying it is “moderately important”.

As ESG adoption progresses and asset owners’ expectations of managers on reporting requirements on ESG issues increase, managers will have to demonstrate their capabilities in this area.

“Against the backdrop of Covid-19 and environmental calamities, along with the strong push from policymakers, ESG-based investing is expected to evolve at a faster rate,” says Cerulli associate director Leena Dagade. “As awareness of the concept rises, investors are expected to take cognizance of not only material financial risks to their investment portfolio, but also external risks such as environmental and social factors that could pose risks to business operations, weighing on financials and impacting investment returns. Hence, it is necessary for managers to stay relevant by building ESG teams and investment capabilities to grab a share of the institutional business.”