Inflation and Russia-Ukraine crisis causes shift in ESG approach

Kathryn Saklatvala, Head of Investment Content at bfinance

A new poll from independent investment consultancy, bfinance, on institutional investors’ responses to macroeconomic and geopolitical developments has revealed widespread re-evaluation of Environmental, Social, and Governance strategies and asset class exposures.

Some 418 institutional investors (pension funds, insurers and others) from 39 different countries contributed to the ‘What Are Investors Thinking Now?’ study.

What was investment like in Q1?

Nearly half of investors had direct exposure to Russia before Q1, of which 45% have either exited or are in the process of doing so, obstructed in many cases by illiquidity and lock-ups.

Meanwhile, 39% of investors—including 41% of pension funds—said that said recent geopolitical developments will lead or have already led to a re-evaluation of their ESG approach, either internally or via the changing practices of their external asset managers.

Furthermore, the report also showed that four in five investors expressed concern that inflation and rising rates would impair their ability to achieve medium-term investment objectives and 41% expect to increase the inflation sensitivity of their portfolios this year.

The poll showed a corresponding shift in asset allocation, with real assets receiving attention: 46% of investors expect to increase exposure to infrastructure in the next 12 months.

Following a rather dramatic and sobering first quarter of 2022, many institutional investors are grappling with pressing macroeconomic and geopolitical developments and must also now scrutinise how their portfolios have weathered significant market declines.

What were the key insights of bfinance’s survey?

The survey run between 29th March and 4th April. This snap poll is an effort to provide additional clarity on the views of the investor community at this challenging time.

Russia

The snap report showed while 52% of investors had no direct exposure to Russia heading into Q1, nearly half of investors had direct exposure to Russia. During Q1, 45% of investors with direct exposure to Russia either fully exited (10%) or are in the process of doing so (35%), the latter of which has been caused by obstructions to illiquidity and lock-ups.

Manager performance

Alternative Risk Premia (ARP) and Hedge Fund managers delivered high satisfaction ratings in Q1, with 51% and 57% respectively. However, investors showed the lowest satisfaction with the performance of asset managers in Emerging Market equity and debt (23% and 24%).

Environmental, Social, and Governance (ESG)

According to the survey, 39% of investors said that recent geopolitical developments will lead or have already led to adjustment of their Environmental, Social, and Governance (ESG) approach, either in-house or via changes made by their external asset manager partners.

Several others also cited that while the conflict had not itself affected their processes, it reinforced the need for a sophisticated ESG approach. Emerging market country exposures, controversial weapons and fossil fuel firms are coming under particular scrutiny.

Inflation and rates

With 4 in 5 expressing concern that inflation and rising rates would impair their ability to achieve investment objectives, 41% expect to increase the inflation sensitivity of their portfolio in 2022. 14% are “very concerned” about the impact of inflation and rising rates on their ability to achieve medium-term investment objectives; 68% “moderately concerned”.

Asset allocation

Macroeconomic conditions are boosting allocations to illiquid strategies. 46% expect to increase exposure to infrastructure in the next 12 months vs. 31% in the last 12 months.

Strong momentum is also evident for surging Private Debt and Real Estate allocations, with 27% of investors increasing exposure to equities in the past year while 22% plan to do so. Other allocations on the rise include Private Equity, Hedge Funds and Agriculture/Forestry.

What are bfinance’s executive thoughts on the survey?

This poll surveyed 418 investors in 39 countries, including 162 pension funds and 82 insurers, and is a precursor to bfinance’s upcoming biennial Asset Owner Survey, later in 2022.

Kathryn Saklatvala, Head of Investment Content at bfinance, said: “We are very grateful indeed to the senior investors who contributed their insights a few days ago for this report.”

“To some extent, the asset allocation changes we are seeing here represent a continuation of some longer-term shifts, such as the shift in favour of illiquid strategies and real assets.”

“Investors’ concerns about inflation and rising rates—which come through in these statistics—are giving greater impetus to these trends. It is interesting to see the large minority of respondents for whom geopolitical developments are prompting a change in ESG approach.”

“This has been focused on topics like weapons manufacturers, energy firms and country exclusions. Even among those that indicated that the conflict would not affected their ESG approach, many said that it had illustrated the importance of having a robust approach here.”

“Indeed, we saw cases where ESG-oriented investors had significantly reduced or eliminated Russia exposure ahead of 2022, which benefited performance in Q1,” she further said.

Frithjof van Zyp, Senior Director, Client Consulting in Australia at bfinance, said: “The views of institutional investors in Australia that responded to the snap poll are very much in line with their global counterparts with nearly half of Australian institutional investors having some direct exposure to Russia. Of those, 55% are still trying to exit due to illiquidity and lock-ups.”

“Less than 30% of Aussie respondents said that geopolitical events will lead to adjustment of their ESG approach, which is slightly below the 40% figure across respondents globally.”

“Infrastructure and Private Debt were flagged by Aussie institutional investors as classes where they will increase allocations as percentage of portfolio assets in the next 12 months.”

“This is perhaps not too surprising given the defensive nature and natural inflation hedge characteristics that are available with these asset classes. However, caution will be required when choosing infrastructure strategies since not all are created equal as an inflation hedge.”