IDEIAS

 

What does 2025 hold for sustainable investing? Jason Mitchell talks to Hortense Bioy, Morningstar Head of Research, about how sustainable investing has reshaped asset flows over the last several years; what the suspension of the net zero initiatives could mean for investors; and why sustainable investing can survive Trump 2.0.

Recording date: 31 January 2024

Hortense Bioy

Hortense Bioy is head of sustainable investing research for Morningstar. She leads Morningstar’s environmental, social, and governance global research efforts, with the objective of educating investors and providing them with the tools they need to evaluate funds through an ESG lens. Prior to assuming this role in February 2021, she was responsible for Morningstar’s sustainability research in EMEA for three years. Prior to Morningstar, Hortense was a financial journalist at Bloomberg.

 

Episode Transcript

Note: This transcription was generated using a combination of speech recognition software and human transcribers and may contain errors. As a part of this process, this transcript has also been edited for clarity.

 

Jason Mitchell:

I am Jason Mitchell, head of Responsible Investment Research at Man Group. You’re listening to a Sustainable Future, a podcast about what we’re doing today to build a more sustainable world tomorrow. Hi everyone. Welcome back to the podcast, and I hope everyone is staying well. I think most people would agree that looking back there really was a brief period, let’s say between 2018 and 2022, that many would call kind of a golden age of sustainable investing. Aside from the memes that went around poking fun about the sudden emergence of ESG experts, this period was basically characterised by ambitious policymaking, a rush to build out sustainable finance teams, onboard ESG data, join initiatives, announce net-zero commitments and launch investment strategies aligned to regulations like the EU’s SFTR, which leads us to 2025. And the notion in this episode that we’re at the end of one era and the beginning of another, one that’s more mature, more rigorous, has a clear eyed understanding of sustainability, both its strengths and faults, and hopefully one that’s focused more on tangible action rather than notional underdeveloped commitments.

So this episode is a really good reminder that for all the things that appear to be changing, there are many things that aren’t. Risks are still risks, factors or factors, energy and resource efficiency are still pervasive themes throughout history. None of this is going away, which gives us room to discuss the 2025 picture about regulations, AI, and the energy transition, not to mention the future of net-zero, which follows on from the recent Tom Gosling episode, and it’s why it’s great to have Hortense Bioy on the podcast. I’d call her a whisperer of sorts of future trends, AUM flows and strategy developments whose insight and analysis can turn retrospectively as well as into the future.

We talk about how sustainable investing has reshaped asset flows over the last several years, what the suspension of the net-zero initiatives could mean for investors, and importantly, why sustainable investing can survive Trump 2.0. Hortense is head of sustainable investing research for Morningstar, she leads Morningstar’s environmental, social and governance global research efforts with the objective of educating investors and providing them with the tools they need to evaluate funds through an ESG lens. Prior to Morningstar, Hortense was a financial journalist at Bloomberg. Welcome to the podcast, Hortense Bioy. It’s great to have you here and thank you for taking the time today.

Hortense Bioy:

Thank you for having me, Jason. It’s a pleasure.

Jason Mitchell:

Absolutely. We’ve been talking about this for a while, so it’s great to see this happen. Hortense, let’s start with some scene setting. Notwithstanding politics and its implications, what do you see as the big themes as outlined in the latest Morningstar report titled, Six Sustainable Investing Trends to Watch in 2025?

Hortense Bioy:

So maybe yes, you said there were six, but if I may, I’d like to focus on three main ones because there are three themes that are really pertinent and currently unfolding, and those are ESG regulations, artificial intelligence and transition investing. So if I can start with ESG regulations, people love regulations especially in Europe. It’s going to be a testing year for ESG regulations, especially in Europe because as we speak, they are reassessing the ambitions with regards to ESG disclosure requirements for companies. This is this infamous omnibus now that includes CSRD, CSDDD and the EU taxonomy. So it’s a testing year because they will have to simplify this package, but at the same time continue to send a signal that the EU is really serious about sustainability. That’s the first theme.

The second one is artificial intelligence. That was a prominent investment theme last year, and it of course going to continue to rise on the agenda of investors, all type of investors, but sustainability focused investors will be really interested in what’s happening on the environmental front as well as the social fronts or ethical fronts. Environmental front, why? Because it’s not secret that AI, although it holds great potential to help address climate change and other sustainability goals, it is also very carbon intensive, or should I say, no, it’s very hungry in energy, which can also lead to higher carbon emissions. So investors want to know what tech companies and other companies will do about this.

The second aspect to AI, as I say, is more social or societal. Investors want to know how companies are going to address data privacy, how they’re going to fight fake news also, although this is not going to be a big fight in the US, but outside of the US, this is certainly something that matters to people. How are they going to address biases, copyright infringements, among other issues? These are financially material issues. This is just not social issues. It will also over the long-term potentially impact the performance of some of these companies.

The third theme is energy transition. So I think it’s become a buzzword now. I think everyone agrees that the world needs to decarbonize, but I think we need clarity around what that really means and what the role of investors really is when it comes to transition. But what’s interesting is that, as I said, it’s become a buzzword. It’s also encompassing a number of things that we probably need to unpack. So we’ve got energy transition, we know a lot of money is flowing into renewable energy and other green technologies, that will continue. We have investing in transitioning companies. That’s another concept that I know Jason, you came to discuss later in this podcast. And there’s also transition finance, which was actually another theme in our reports, like green bonds and other types of bonds that will help companies to transition and send a clear signal that companies are serious about the transition.

Jason Mitchell:

Excellent. Yeah, that backdrop is really helpful. But the reality is we can’t really talk about sustainable investing, I think without discussing some of the barriers it’s obviously facing. So let’s start with asset flows, which is sort of your wheelhouse. It looks like despite a lot of different pressures, sustainable investing broadly continues to see inflows. I think by your numbers shows around 16 billion US in Q4 with I think the important caveat that it now seems to be under growing the market in general. And Europe, no surprises leading the way at 18.5 billion of inflows in Q4, which is a big quarter on quarter pickup from Q3. So I guess first, what do you make of these flows? Are we still seeing residual recategorizations into article eight and article nine? And I guess second, if 2023 was the year of recategorization for the EU, what will 2025 be?

Hortense Bioy:

So, there’s a lot of aspects to your question, Jason, but yes, if I can give a brief overview of what happened really in 2024, I think it was a disappointing year when you look at flows. Because although we’ve seen flows going up and down over the past seven years, and of course 2021 was the big year with record inflows, and everyone was very supportive of ESG, but also the broad market was doing very well. They were record flows into funds in general in 2021. And so that’s normal that we also saw record inflows into ESG funds in 2021. Since the war in Ukraine in 2022, that’s when things started becoming a bit more complicated. And last year there was this bull market driven by tech stocks primarily, primarily in the US. And there was this also growing ESG backlash in a political environment that was very uncertain because let’s remember that last year was a year of election in many, many countries.

And at the same time, there was regulatory uncertainty around ESG, ESG frameworks. I’m referring here to other European regulations here around SFGR, because you mentioned reclassifications, but also in addition to that, there was high interest rates. So there was a lot of factors that really proved to be headwinds for ESG funds. So we saw the lowest inflows in seven years gathered by this type of investments. Now it’s important to understand how we classify ESG funds, and also what I’m talking about here. Here, I’m talking about open-end funds and ETFs that use ESG factors at the centre of their strategies. So I am not including funds that just do ESG integration, and I’m not including funds that just exclude some sectors or activities. So they’re not exclusionary funds. They’re really focused on ESG factors and sustainability criteria.

Jason Mitchell:

And obviously that means not including segregated mandates.

Hortense Bioy:

Absolutely. It’s important to point that out. Also, not private markets. So it’s actually only part of the sustainable investing landscape. And through my conversations… Although I can’t talk about private markets here because it is very little data there. Through my conversation with asset managers, it seems even on the separate accounts or segregated mandate side, there has been lower inflows, but it depends also on the regions. So outflows in the US for sure, but still inflows in Europe and Asia-Pac.

Jason Mitchell:

Got it. And I guess back to that question, if 2023 was the year of recategorization, what do you think 2025 will be? Will it be, for instance, the year of name changes given ESMA naming rules?

Hortense Bioy:

Absolutely. We are predicting a total transformation of the ESG fund landscape in Europe driven by two anti-green-washing rules. You have the SDR, so the sustainability disclosure requirements in the UK, and you have the ESMA fund naming rules in the EU. So investors have until the end of May to decide whether they’re going to change the name of the funds or they’re going to adjust the strategies. And here I’m talking about funds that use very specific terms in the names like environmental, ESG, sustainable, and so on and so forth.

Now, according to our analysis, we expect between 30% and 50% of all ESG funds in the EU to change the names. It’s significant. We’re talking about potentially more than 1,200 funds. So what we say to investors is that they really need to monitor in the next few months what’s going to happen. If they see a name change, they need to understand, “Okay, I’m seeing a name change, but has my strategy change or not?” They can’t assume that the strategy hasn’t changed. And if the funds have kept their names, then they need to understand the implications in terms of portfolio, what’s changed in the portfolios, what’s changed also in terms of risk return profiles.

Jason Mitchell:

That’s really helpful. But can you talk about how global and EU flows compared to the picture in the US which has seen outflows not big, around 4.3 billion in Q4 alone, but is there a story beyond the obvious politicisation of ESG to explain it?

Hortense Bioy:

So the ESG backlash in the US is one factor, but I think you’re right in implying that it’s probably not the only one. Performance has been an issue after years of claims that ESG funds are bound to perform better than non-ESG funds. And we had great performance during the COVID years. After that, since the war in Ukraine, this theory didn’t hold. And in general, ESG funds have underperformed, and that’s primarily because also active managers haven’t been doing very well, and there’s predominantly active funds in the ESG fund space. And I wouldn’t mention fees, I don’t think fees if you see… Because actually active ESG funds are not more expensive than active non-ESG funds. When you look at passive funds, you may find ESG funds that are a little bit more expensive than non-ESG funds. But we are talking about a few basis points, that doesn’t explain some of the underperformance.

Some of the underperformance can be explained by primarily sector biases. As you know, there’s a lot of different types of strategies out there. When you also turn to thematic funds like clean energy, clean tech, or even EV funds, or… They’ve struggled. Climate solution funds have struggled, but especially clean energy, clean tech funds, they haven’t performed well at all over the past four years because of high interest rates. So high financing cost, material inflation. You also had supply chain disruption. There were lots of factors that explained also the underperformance of that sector in the listed market. The private market has different dynamics. So performance hasn’t helped. But also there has been some green-washing concerns, and still now investors are really wondering about the impact or the ESG credentials of some of those strategies. And I would say I think that’s probably it. I think these are the most obvious factors that have not encouraged investors to invest in ESG funds in the US.

Jason Mitchell:

It’s interesting. I was going to ask, to what degree has recent performance compounded these effects? And I realise you might use some other proxies. I’m looking at the MSCI bar of factor returns, and according to that, on a 2024 basis, their ESG factor and carbon efficiency factors were among the worst performing for the year. So I guess that’s one point. But I guess on the other hand, it’s interesting to me, why do you think, at least in Europe, article eight asset flows have remained so resilient when equity relative returns have generally underperformed, as you say? The numbers I show at least over the past year, and I’m just looking at the past year, but I think the rolling three year would support this, but at least over the past year, it’s sort of underperformed around 200 basis points or more.

Hortense Bioy:

So it’s important to understand that actually most of the inflows into article eight funds have been into fixed income, so not equity. So of course performance could have been a contributing factor to this result. But it’s interesting to see that ESG investors have been attracted, and the article eight funds actually in the EU have attracted more money in fixed income than conventional funds. So I’m referring to article six year. So I don’t know if that directly answer your questions, but no equity ESG funds haven’t done well at all in terms of inflows.

Jason Mitchell:

I want to kind of back up this entire preamble is actually incredibly helpful just in terms of scene setting. But one of the big questions I wanted to ask you, and I think a lot of people are kind of wondering is from your vantage point, can sustainable investing survive Trump 2.0? And if it can, why?

Hortense Bioy:

So hey, it survives Trump 1.0 and there is more money in sustainable investing today than there has ever been. I have no doubt that sustainable investing will survive Trump 2.0. So I think maybe it would be helpful to take a step back and really clarify what we’re talking about when we talk about sustainable investing. We are really talking about risks and opportunities related to environmental and social factors. This is what we’re talking about. So on the opportunity side, if I can start there and just pick an example of the energy transition, which was mentioned at the beginning. The energy transition alone will require more than $5 trillion in investment every year. So there is a need for investment in renewable energy, energy efficiency, energy storage, green tech in general, you name it, infrastructure as well, a lot of different things. There is also the need to finance the transition in emerging markets.

So this funding of course won’t come only from investors, but where there are opportunities to make money, investors will be there. And that’s just the transition. There are many other opportunities. I can also name know secular economy, biodiversity, adaptation, which I think is also something you want to talk about, is another theme, is another key area that investors will want to put more money into because companies must prepare for a changing world. There is no choice. Now, this is your opportunity side. Now, on the risk side, more money will flow into sustainable investment strategies going forward. Why? Because investors need to manage growing ESG risks. Trump may be President now, but the ESG risks are not going away. On the climate front, if the world doesn’t transition fast enough, this risk will intensify. Physical risk will be greater. This is just a fact. And companies that fail to prepare and transition will face stranded assets and losses.

And today, investors want to identify the companies that are the most exposed to transition and physical risks, those that fail to prepare. And they also want to identify and invest in the companies that are the best positioned for the transition. So I’ve talked about opportunities and risks and supporting all of this, there’s increasing availability and quality of ESG data. So as we know, investors have faced challenges with ESG data for a long time, and this is being addressed now. In Europe, we mentioned CSRD earlier and outside of Europe, there’s going to be also better data with the ISSB. So all of this is going to give more confidence to investors about integrating ESG factors into their decision. So I hope I have convinced you that it’s not four years of Trump that is going to derail this momentum.

Jason Mitchell:

No, it’s a great answer and I love the optimism in that. But I guess if I can not inject a little bit of current realism into that, because I buy into your long-term picture. But look, let’s face it, with the net-zero banking alliance falling apart, the net-zero insurance alliance essentially dissolve last year and the net-zero asset manager’s initiative now suspended, it kind of feels like the future of net-zero has to be a necessary part of the conversation we’re having right now. A year ago, just before COP 28, you’d stated your quote, “We should not give up on 1.5 C. We should resist the temptation to move the goalposts because that would reduce the sense of urgency.”

It’s a pretty powerful statement and a statement that I personally have a lot of sympathy for. But with Copernicus, the EU Earth Agency, indicating that we’ve already breached 1.5 C and support for collaborative net-zero initiatives diminishing, do we need to reexamine the case for net-zero? It’s a question I’ve just finished asking Tom Gosling in a prior episode, but how do you think about this in the broadest terms? The big question for me is do you expect investors to reset, to recalibrate potentially to 2 C, or to generally retreat from decarbonization efforts?

Hortense Bioy:

So I don’t think any of those two options will happen. So 1.5 or net-zero are terminologies that are very imperfect in nature. This is what science has told us, we can limit the biggest damage to our planet if we limit global warming to 1.5. It’s maybe a number we can put on our models, but I don’t think it makes much sense to move that to 2 degrees or 2.5. These are just numbers. Well, what really matters, and this is a part of your question, what really matters is can we afford to retreat? Will investors retreat from decarbonization efforts? And I don’t think either investors or companies will retreat from decarbonization efforts. And even if they gradually move away from those terminologies that you mentioned, so net-zero and 1.5, I think they will continue to put pressure on companies to decarbonize. The companies themselves will also decarbonize.

We are seeing more and more companies commit to decarbonizing through the release of science-based targets, and we are seeing more and more transition plans and regulators are actually also pushing for more disclosure of transition plans. So what investors are now doing is that they’re assessing those transition plans and they are trying to determine which ones are credible and which ones aren’t. And they’re engaging with companies to understand what the journey really looks like. So I think this is intensifying rather than just saying, “Okay, well because last year we reached 1.5 degree and it was the hottest year on record. Okay, well there’s nothing much we can do. We are going to stop.” So yes, I said earlier, or was it last year that moving the goalpost was dangerous because it would reduce the sense of urgency, even if there is less urgency, there’s still action.

Jason Mitchell:

That’s incredibly helpful. I want to revisit the issue around adaptation and resilience a little bit later in the podcast. But first, I want to call you out on one other thing. In early 2023, you voiced concern about the fate and future of climate action 100 and the net-zero asset managers initiative because of the emerging US anti-ESG backlash. It was pretty prescient back then, but I guess that leaves us now. So where do you see the industry rebasing expectations going forward? How do you see and I guess, expect investors to thread the needle, whatever that means, but it’s been used more and more particularly around stewardship, et cetera, in order to satisfy different clients in different jurisdictional interpretations of sustainable investing?

Hortense Bioy:

Clearly the political climate in the US is complicating the work of these managers and it’s really created this big dilemma. They can’t talk too much about what they do. They can’t make big statements anymore. They can’t do anything or say anything that would upset people and especially the Republican Party in the US. But at the same time, they still need to serve their clients. And those managers know that climate risk is investment risk. And we’ve heard that phrase, which is a brilliant phrase, but it’s true, so many times over the past few years. So they need to convince the clients that what they’re doing for them, but not only for them in the little strategy that the client has bought, but more broadly in terms of policy advocacy, in terms of direct engagement with companies, they are really pushing for that agenda, reducing climate risk in companies.

I think it’s quite difficult for them to do that in the US because they face a lot of contradictions. Now, it is probably easier for European managers who have reaffirmed their commitment to net-zero. They have a clear strategy in terms of how they allocate capital towards companies that are transitioning and how they really plan to support those companies and also provide more innovative products that clients want. I think it’s more tricky for US managers to do that now because they may sound less credible, to be honest. I’ve heard many contradictions, and I understand their dilemma. I understand it’s difficult. I really understand that. I’m not saying it’s wrong because they are in that position, very tricky position, but that creates opportunities for other managers who are committed to sustainability and they can evidence it much more easily.

Jason Mitchell:

I was going to ask you, why did Morningstar stop its asset manager ESG assessment last year, particularly around the ESG commitment levels? And also with that in mind, how does the move towards more green rehashing and the changes in collaborative initiatives that we’ve talked about more generally impact Morningstar’s research, particularly of asset managers?

Hortense Bioy:

So the ESG commitment level for asset managers was a separate assessment. So this is not something that we included in our best known parent analysis, so we could stop doing it without really impacting the rest of the ratings that we have. So that’s what we did. And again, this is because we couldn’t scale this assessment. But there are still questions that are asked by our analysts when they meet with parent companies. We call them parent, but they’re asset managers. Of course, we want to hear that the manager has a consistent philosophy, has a consistent process in place.

We want to understand, because this is what our investors and our clients want to know is that what do we think of asset managers? And of course we want to hear something that makes sense. Either you are a manager that focuses on, I don’t know, passive or you focus on a growth manager or you’re focused on quality. Some managers also focused on ESG. Of course, those managers will be asked questions about their ESG commitments and the fact that they belong to a certain initiative, that they contribute to elevating standards in the industry. So that matters, but more specifically for asset managers that really are dedicated to ESG, it matters much less for other types of managers.

Jason Mitchell:

Super helpful.

Hortense Bioy:

So green rehashing, I don’t think this is going to happen. We are not going to see green hushing from those managers that are really dedicated to sustainability and ESG because this is their bread and butter, this is what they do. This is their identity. For the others, it’s different.

Jason Mitchell:

Thanks. Let me ask you this, because I kind of feel like this literally will be a standard question going forward for all guests on this podcast. But in your perspective, what’s the silver lining in all of this? And by all of this, the anti-ESG backlash, the potential dissolution of initiatives? Does a silver lining even exist?

Hortense Bioy:

Sure, sure, absolutely. I think the anti-ESG backlash has prompted a maturation of the industry. I think this is the end of an era and the beginning of a new one where there’s going to be fewer empty promises. So yes, fewer commitments for sure, but there’s also going to be more transparency, a clarity of language and a better understanding of sustainability and sustainable investing. So we are going to see companies, and we’re already seeing this, companies shifting from making grand promises to focusing on tangible actions. So real initiative that align with their core business strategies and that add value to the business. So it’s just not going to come from marketing department anymore. It’s going to come from really the top and it’s going to be something genuine, something impactful, and something they can evidence in terms of the value add for the business.

And the financial industry is also going to evolve. It’s already evolving towards avoiding jargon and using clearer and more specific language that everyone can understand because there has been too much jargon in the industry. So I think this anti-ESG backlash will force us to be clearer in what we mean and be more specific. When we say investing in sustainability, what does that mean? Are you investing to address climate change? Are you investing to mitigate certain risks? So asset managers and everyone will need to be more specific about what they’re really offering in terms of products and what is trying to achieve in terms of ESG outcome.

And regulators in Europe, but not only Europe, in other parts of the world as well, except the US of course, have played an essential role in this transformation. So in this maturation of the industry, despite variations of course across jurisdictions, but there has been really this global push for ESG disclosure requirements, I mentioned ISSB earlier. There has been some anti-green-washing rules and also the creation of taxonomies that have really helped build a better understanding of not only what sustainable activities are, but also the practises and what investors are completely entitled to expect from the strategies that are being offered to them. So I think this is going to help build trust in ESG initiatives. So I think it is all good because it’s also going to help direct capital towards the sectors and activities that need to contribute to a better world.

Jason Mitchell:

I definitely agree with that. Hortense, I want to come back to, I guess our conversation around the approaches to climate investing. How do you think about the shifts across basically three climate buckets, call it decarbonisation slash mitigation, transition which we talked about, and adaptation, I.e physical risks vis-a-vis a global political environment? So maybe two questions. First, does the cooling and decarbonisation efforts spill over in your mind to the energy transition, which has seen steady AUM increases? And I guess further to that, does climate adaptation, which is interesting, it’s an area that seems to be pretty, in my mind, underdeveloped from a public markets perspective, does it become increasingly a necessary refuge in politically uncertain times?

Hortense Bioy:

I think we won’t have a choice but to think more about adaptation. As temperatures increase and extreme weather event becomes more frequent, the need to adapt and build resilience is going to be inevitable. So we know that companies are thinking more and more about this because they see this happening. And also increasingly investors are asking about, for example, where the assets are located because they want to know if they are more susceptible to storms or hurricanes or other types of thing that will disrupt the business. So I guess when you talk about adaptation, there’s really two lenses that you can consider there. So there’s always the risk aspect and the opportunity aspect. On the risk side, this is what I mentioned just now, the understanding really the physical risk and how companies are prepared really to adapt to rising temperature in some places. Or if there are risks that sea level rises, what are the implications in terms of if there are floods, what happens to the factories in the supply chain?

So all these questions are now being asked by investors, not all of them, because it is still an emerging area, I think. But there is clearly growing awareness that it is important because although if companies don’t want to mitigate risk, what they are going to have to do is to adapt in one way or another. So that’s a risk aspect. Another aspect is the opportunity, the investment opportunity side. So an adaptation is also a theme that investors should also consider because we know that as companies need to adapt, there’s going to be a greater need for adaptation type of products and services. So companies that provide these products and services will benefit from this trend. So it’s interesting that so far, this is not something that’s been talked a lot about, but increasingly we are going to, at least the Morningstar sustainability, but also we can hear more and more conversations about adaptation in the market.

Jason Mitchell:

Interesting. Really agree with that. Climate investing has had traditionally a big emphasis on decarbonisation, but not necessarily investing in heavy emitting companies who are transitioning. Per this, I’d point to Professor Kelly Shue at Yale’s great paper titled, Counterproductive Sustainable Investing, which asserts that sustainable investors tend to overweight green firms and underweight brown firms. Where do you see transition strategies fitting in in all of this? And I think more importantly, how does Morningstar distinguish between for equity investors, portfolio paper decarbonisation and real world decarbonisation?

Hortense Bioy:

We are really trying to make investors aware of the different types of strategies that are available to them. I think this is really part of our mission to do that. So it’s not like we necessarily say one strategy is better than another because investors have different goals and they have different beliefs. So I think it’s not our place to say that investing in low carbon strategies is pointless because it’s not really changing the world. It doesn’t have an impact on the real world, and it’s better to invest in high-emitting sectors, especially those that are necessary for the transition. We don’t say that, but we just explain the drivers or the different drivers for these different strategies and what they should expect in terms of risk returns, profiles, the role that the strategies play in a portfolio, and also what the sustainability profile of these strategies are.

So not only in terms of carbon intensity or… There are all the considerations, and there are trade-offs sometimes, there are trade-offs, and investors also need to understand that. But I think I agree with you. There is this increasing trend that we see in the market of investors wanting to shift away from simply decarbonizing investment portfolios by divesting from high-emitting assets to companies that have transition plans, credible transition plans, and also those that enable the transition. So here I’m referring to the solutions, the solution providers. So that narrative of course makes sense, but we are not here to say that one is better than the other. They all have different characteristics and investors should understand those to manage their expectations.

Jason Mitchell:

I’ve heard you on many panels over the years, and correct me if I’m wrong, but I guess I’ve interpreted that to be that you’ve been somewhat critical about the impact that investors can potentially have, different investors distinguishing them. Investors have talked about generally the channels of influence, namely, engagement and specifically impacting the cost of capital. What do you see as the limitations, especially in the context of net-zero? Tom Gosling has talked about the fact that investors who are unable to influence climate outcomes should instead focus on influencing the environment to drive climate outcomes. How do you think about this functionally speaking? How do you measure manager capabilities? And obviously I realise that you’re no longer doing the ESG assessment, but I think in an abstract sense.

Hortense Bioy:

So it’s an interesting question when you look at the macro level and how capital moves from one place to another and what drives this capital flows, and also the merits of signalling, which is often not spoken very positively. And also the merits of signalling, because you hear a lot of criticisms about this is virtual signalling, this has no impact, this and the other. Actually, I think the research, I don’t think we have enough research. I don’t think there is consensus on these topic. And there are signals in the market that do have an impact that also moves capital. But beyond that, I want to say that anyway, policies and regulations don’t happen in a vacuum. So if companies or civil society feel or investors for that matter, feel that something needs to happen, they need to have those conversations, they need to push governments, they need to talk about it.

And this is what also thought leadership does. It’s like, okay… And lobbying as well. It’s an interesting aspect, lobbying, which is very, very obscure and opaque and nobody knows what’s going on, but there’s a lot of lobbying in one way or another. These things impact the markets, they impact policymakers as well. So let me give you an example. If investors hadn’t pushed regulators to introduce ESG disclosure requirements, I don’t think we would have them today. I think it’s investors who realised that there were systemic risk and especially climate change that needed to be addressed, and they needed data for that.

So this is what happened over the past few years in every single region, investors put pressure on companies through their engagement activities, through all the things that they were doing, through voting and through research, they were saying, “We need more data on this. You need to disclose your climate risk. You need to disclose whatever you feel is financially material to your business.” And we have this disclosure today, not completely yet, but it’s coming. It’s coming. So I think we can’t deny or undervalue the power of investors. So that’s to answer your question of the utility of sustainable investors. And at the more micro level, investors can also engage with companies, deploy capital to invest in certain technologies. So this is happening too. So the role of investors in making the world more sustainable is undeniable.

Jason Mitchell:

You’ve talked a lot about green-washing in the past. How has your notion of green-washing evolved through, I guess I’m thinking about the complicated landscape of standards out there, SFDR, SDR, regional labels, not to mention changing expectations as well as the recent emergence of green hushing?

Hortense Bioy:

So I’ve always said that green-washing was… Of course there is intentional green washing. So it’s about making unsubstantiated or misleading claims about the stability characteristics of something, either a company or a product. But I think it’s also often a mismatch between someone’s expectations and what they get. So I’ve always said that education is very important. I’m talking about sustainable funds here. It’s important to manage investors’ expectation, but also be clear about what you’re selling and what the investors should expect.

So I mentioned regulation earlier. Of course, those anti-green-washing rules are useful because they forced asset managers to clarify their language, to clarify what should be expected in terms of ESG outcomes, in terms of type of companies or securities they would have in a portfolio. So that was important and that’s good. So I think of course now we’re seeing less green-washing today than there was probably a few years ago. The DWS story really, I think probably scared a lot of asset managers and they watered down the claims, and they really made an effort to make sure that the investors understood really what they were investing in, but it, especially regulators that forced that as well.

Jason Mitchell:

So last question. I’ve heard you defend in the past European prescriptive regulatory approaches relative to the US’s more principles-based stance. I’m actually quite sympathetic to your view, but what have the last several years of the EUS, FDR, CSRD and CSDDD taught you about where to find a balance between sticks and carrots, I.e incentives versus disincentives, especially in light of the recent push towards greater simplification through the omnibus?

Hortense Bioy:

Well, I probably defended the European approach because there is virtually nothing in the US.

Jason Mitchell:

I agree.

Hortense Bioy:

There’s no regulation related to ESG. And kudos to Europe. Europe is a clear leader in sustainability in really pushing the sustainability agenda in terms of disclosure, but also in terms of commitment. But it was also important to define all of this and make sure, again, that everyone uses the same language. What is a sustainable activity? What does that look like? What are the minimum criteria for certain things to be considered as green? What do we consider brown? What do we consider as a transitional? So it was necessary. I think the problem was probably that it was too ambitious. When we look at CSRD in particular, it was way too ambitious in the timeframe that was given to companies, and this is why some people were asking for delay or a simplification of the requirements.

So it’s coming and it’s very likely that the situation in the US has influenced Europe in that regard and has also accelerated this simplification, which is not a bad thing, but I think some people would be wrong in thinking that it means Europe is not committed to sustainability anymore or is not as ambitious. I think Europe is as ambitious as it was before, but it needs now to work with other constraints in terms of competitivity. There also, and this is funny, we haven’t actually talked about that, but geopolitical pressure, we didn’t talk about China, but also this is an important piece of the transition. And so, it’s a complex landscape now that wasn’t there a few years ago. So it’s normal that EU regulators wants to adjust and lighten the load, the reporting load for companies. I think everyone will appreciate that, and I think Europe will come out stronger. At least we hope that Europe will come out stronger in a few years time because of these measures.

Jason Mitchell:

Great. It’s a great way to end. So it’s been fascinating to talk about how sustainable investing has reshaped asset flows over the last several years, what the suspension of the net-zero initiatives could mean for investors, and importantly, why sustainable investing can survive Trump 2.0. So I’d really like to thank you for your time and insights. I’m Jason Mitchell, head of Responsible Investment Research at Man Group, here today with Hortense Bioy, head of Sustainable Investing Research for Morningstar. Many thanks for joining us on a Sustainable Future, and I hope you’ll join us on our next podcast episode. Hortense, thank you so much for this.

Hortense Bioy:

Thank you very much, Jason. I enjoyed it. Thank you.

Jason Mitchell:

I’m Jason Mitchell, thanks for joining us. Special thanks to our guests and of course everyone that helped produce this show. To check out more episodes of this podcast, please visit us at man.com/ri-podcast.

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