Many pension funds appear open to this sentiment, and a dominant line of thought for U.K. and European institutional investors this year is reestablishing focus on ESG following a year in which inflation concerns dominated the conversation.
However, there's evidence that European investors may also be going the other way. Investment strategies labeled as ESG-linked under the European Union's Sustainable Finance Disclosures Regulation Article 8 criteria registered their largest quarterly outflows on record of €26.7 billion ($29.2 billion), while the strictest category of Article 9 funds saw their first quarterly outflows in the fourth quarter of 2023 at €4.7 billion.
But Alexander remains convinced of ESG's long-term place in portfolios.
"If there's an investing strategy that outperforms the market every single time, then everybody will be in it. The reality is sustainability is going to show short-term ups and downs," Alexander said. "Yet I still strongly believe that over the long term, when you consider the full range of risks to investments, funds that consider properly ESG risks and impacts are going to outperform. There needs to be greater consideration of long-term investment decision-making, particularly for pensions, as most of these funds have liabilities that are decades ahead."
Alexander's comments echo the "tragedy of the horizon" remarks made in 2015 by Mark Carney, former Bank of England governor, that short-term investments are still failing to incorporate climate risk.
The SFDR itself, however, has shown signs of teething problems, as following its implementation in 2021 it was soon transformed into a de facto labeling regime, as opposed to its broader intention as a transparency framework. It also experienced an en masse downgrade of Article 9 funds as criteria tightened and asset managers feared greenwashing allegations.
The U.K.'s response to the SFDR — the Financial Conduct Authority's Sustainability Disclosure Requirements — seemed well-placed to learn from the EU's missteps, for one thing acting as a dedicated ESG fund labeling system from its very inception, according to Alexander.
Last year, Alexander described SDR as "broadly unworkable," related to the seeming impossibility of how firms could accurately define any "unexpected disclosures" in a way guaranteed to follow the rules, while maintaining a right to confidentiality in revealing the exact makeup of a fund.
But, following changes made by the FCA in consultation with the industry, he now thinks the legislation carries real potential to provide clarity in the sustainable investment space. "The FCA has engaged with industry on this. We're really confident that the final product has created a really good system that's going to stand the test of time," Alexander said. "What we want to see now is the FCA working with regulators across the world to try and encourage them to adopt similar approaches, because what we don't want to see is a big divergence of regulation."
As part of the SDR regulation, asset managers can select one of four labels to apply to investment products that seek positive sustainability outcomes, and it is due to take effect on May 31.
SFDR categorizes products on three levels (Articles 6, 8 and 9), in a way that can be seen as hierarchal ESG rankings. The SDR's four categories, sustainable focus, sustainable improvers, sustainable impact, and mixed goals, are not rankings that should be placed against each other but are instead intended to reflect different consumer preferences.
"I think the EU would do very well to look at some of the conversations that have happened in the U.K., particularly the way that the U.K. is involved industry to address some of the challenges and make sure the system and the regime works effectively," Alexander said.
Alexander pointed to an EU consultation on SFDR, published in January and relating to "the usability of the regulation and its ability to play its part in tackling greenwashing," as signs of concrete progress in fixing the framework's issues.
In the U.K., there is also now more clarity on the issue of using sustainability metrics within investing. A paper published by the country's Financial Markets Law Committee in February confirmed that pension fund trustees may consider climate change when making investment decisions, providing an answer to previous concerns that incorporating key ESG factors could be a breach of fiduciary duty.
"This guidance states that it is simply good financial sense to consider sustainability, breadth of impact, and the long-term outlook of investments," Alexander said. "We anticipate that this guidance delivers the clarification necessary to make fiduciary duty legislation much more effective in its purpose."
