A recent CoreData study shows growing appetite for ESG among pension investors. But will the unfolding geopolitical crisis in Eastern Europe necessitate a redrawing of the ESG map?

Few pension products have courted as much controversy as the Self Invested Personal Pension (SIPP). But despite some negative publicity around collapsed providers, complaints, compensation claims and court cases, SIPPs remain a core feature of the UK retirement savings landscape.

Indeed, CoreData’s recent study underscores the popularity of SIPPs among adviser clients. Our survey of 350 UK financial advisers shows nearly nine in 10 have clients invested in a SIPP. This is up from 2020, indicating the growing appeal of the wrapper as savers seek additional control over pension investments. Furthermore, advisers say clients have increased the amount of money put into SIPPs over the last 12 months.

So what is driving these flows into SIPPs? In the main, three letters: ESG. Nearly half of advisers we surveyed say SIPP clients have increased contributions to ESG investments over the past year. The findings of the survey chime with other CoreData studies showing that momentum behind ESG has been boosted by the pandemic.

The increased flows into ESG will be welcomed by asset managers who have launched new ESG funds, repurposed existing funds and ploughed much investment into research and marketing activities.

However, ESG remains a tough nut to crack. Asset managers realize that matters of sustainability are increasingly important to ethically-minded investors. And they realize there are huge sums of money going into ESG and want a slice of the cake. But they also recognize the challenges of building an ESG-focused brand amid investor scepticism on ESG, the rise of greenwashing and difficulties with data, definitions and ratings. And they face the task of differentiating their product offerings in a market saturated with ESG funds.

Given these difficulties, the need to verify and prove one’s ESG credentials and ultimately win the trust of investors will be a key battleground for asset managers over the next few years. And technology will play a crucial role in the competition to win investors’ hearts and minds. New AI tools that trawl through company documents and data to verify ESG claims mark just the beginning of a sustained technological assault on the ESG landscape. Ultimately, technology will prove to be a potent weapon in the fight against greenwashing and that can only be a good thing.

The winners in the ESG space will be those asset managers able to offer innovative and differentiated products that do exactly what they say on the tin. And those managers will be able to substantiate their ESG claims through new ESG tech and data-driven reporting.

But as asset managers look to bolster and authenticate their sustainability credentials, the tragic invasion of Ukraine is muddying the ESG waters and laying bare the limits of classifying investments into ‘good’ ESG and ‘bad’ ESG. For instance, ESG funds have tended to exclude defence-related assets because of the obvious damage and harm that weapons inflict. But if weapons and defence equipment are used to protect a nation and its civilians from an unprovoked and unjustified attack then surely they can be a force for good. The Ukraine crisis exposes the difficulty of categorizing and defining ethical considerations which are transient and subjective in nature.

And with Bloomberg analysis showing ESG funds held over $8 Billion in Russian assets prior to the invasion, the crisis also exposes the shortcomings of ESG labels that pay scant regard to democracy and human rights.

The invasion of Ukraine also throws new light on the debate over divestment versus engagement which has become rather binary and simplified. The crisis highlights the limitations of engagement strategies, with asset managers left with little option other than divesting en masse from Russian assets.

Events in Ukraine therefore threaten to destabilize the foundations upon which some ESG principles are built. The unfolding geopolitical crisis may well necessitate a redrawing of the ESG map.

In addition, the Ukraine crisis will act as a litmus test for whether investors really are prepared to sacrifice returns for the greater good. With global equity markets plummeting, how will ESG investors react? The majority of ESG funds are equity funds and by their very nature are less diversified than their non-ESG counterparts. Furthermore, ESG funds have been hit by a double whammy: the rotation from growth to value and an aversion to fossil fuel stocks which have surged on the back of rising oil prices. While ESG funds were the talk of the town during the pandemic, they are now underperforming and underwhelming.

But while ESG investors might be in for a rough ride in the near term, they should remember that ESG strategies seek to tap into long-term structural trends. And investors with long time horizons – including those saving into pensions — should also bear in mind that geopolitical crises have historically had a short-term impact on markets.

Nevertheless, the current crisis may necessitate a rethink about ESG risk management frameworks. It may also prompt a review of risk management concepts and practices in general. We have recently been struck by two black swan events in the form of Covid-19 and the Ukraine invasion. These events, and the ensuing market volatility, will likely fundamentally alter attitudes to risk. As such, we will need to develop a more innovative and tech-driven approach to risk management harnessing AI, advanced analytics and stress testing.

And ESG needs to be at the forefront of this evolution in risk management. The crisis in Ukraine demonstrates that ESG is still a nascent sector which is evolving and finding its feet. But rather than weakening the ESG argument, the current crisis serves to underscore the necessity of allocating money to investments that have a positive social and humanitarian impact. The events unfolding in Eastern Europe should further focus investor attention on the ‘S’ element of ESG and those UN Sustainable Development Goals relating to human rights. Just as the pandemic shone a spotlight on the health and sustainability of our planet, it is hoped the human tragedy in Ukraine — and our response to it — will further the rights of people to live in peaceful and democratic societies.