Sustainability is great risk management

Cara Williams , Global Head of ESG, Climate and Sustainability, Mercer

For large institutional investors, active assessment of environmental, social and governance (ESG) factors and prudent risk management are one and the same.

A panel at the Milken Institute’s annual Global Conference provided a forum for some of the world’s largest institutional investors to share views on their approach to balancing risk and return through the lens of ESG and sustainability.

The view through this lens is an important topic ? and not just because of the importance of tackling the risks that ESG and sustainability seek to address. CIOs and Executive Directors of large pension schemes and sovereign wealth funds are leading innovation in the sustainable investment arena, forging new approaches and pathways that others can learn and benefit from- with knock-on effects across the wider investment landscape.

The discussion highlighted the extent to which ESG and sustainable investment factors are now viewed as inextricable from more traditional investment criteria. Despite the varying investment objectives and geographic contexts of the panelists that joined the discussion, they reached a resounding consensus on the importance of incorporating ESG and sustainable factors for responsible fiduciaries. Such an approach is not viewed as extraneous to traditional risk management, but a core part of it.

At its core, ESG and sustainable investment approaches provide a framework through which to approach and respond to the long-term and systemic risks facing the environment, economies and communities. The risks associated with a changing climate threaten catastrophic economic impacts – research from the World Economic Forum estimates it is already costing $16m per hour[1]– the knock-on effects are already evident across the insurance industry,[2] with rising costs from extreme weather events driving a rise in insurance premiums – catalyzing corresponding responses across insurance portfolios.

Yet ESG is so much more than the environment. ESG approaches encompass governance factors such as assessing data privacy and cybersecurity risk, yet these are not typically associated with ESG in the same way that climate risk is. Indeed, with the average cost of a data breach now sitting at $4.45m[3], efforts to mitigate them are instead seen as prudent risk management.

Viewing sustainability as a lens is particularly instructive; applying it equips investors with the tools to see risks that might otherwise have gone unnoticed. A gender pay gap is a risk. An opaque supply chain is a risk. Unsustainable practices are inherently risky, and the move towards greater levels of rigor around ESG are helping investors to address a much broader spectrum of risks through more and better-quality information.

Optimizing decision-making requires better data; striving towards best practice across the multiple risk vectors of an ESG and sustainability framework will put investors in a stronger position to drive better returns across portfolios.

Looking through the ESG and sustainability lens is already mainstream among investors operating on the largest scale, but we expect to see it spread even further as more and more asset owners increase their focus on sustainability ? particularly as the more challenging macro environment makes the pursuit of marginal gains even more important.

While regulatory initiatives such as the EU’s Corporate Sustainability Reporting Directive (CSRD) will drive adoption, the desire of investors at all levels to pursue potentially greater upside through the adoption of broader, more granular risk management approaches is also galvanizing momentum.

The leadership of large institutional investors may yet drive a cultural shift where we stop talking about sustainability as a standalone topic and instead see it for what it is: a prudent way to manage risks and seek maximized returns.

[1] Climate change is costing the world $16 million per hour: study, World Economic Forum, 2023

[2] https://www.scientificamerican.com/article/climate-change-is-destabilizing-insurance-industry/

[3] Cost of a Data Breach Report, IBM, 2023