Integrating ESG Information into Long-Term Investment Strategy

The increasing focus of industry stakeholders on responsible investment has led to greater scrutiny of how asset owners integrate environmental, social, and governance (ESG) information into their investment strategies. We identified a gap in the literature regarding the role of ESG integration in setting long-term investment strategy, such as strategic asset allocations (SAAs). Through an interview and survey approach with investment strategy leaders at large asset owners in Australia and New Zealand, our research explores the key considerations for integrating ESG information into SAA, including regulatory changes, evolving stakeholder expectations, and the recognition that ESG risks and opportunities may have a material impact on financial returns over time. Given the prominence of Australian and New Zealand asset owners in the wider international pension system, this research has global relevance.

We found that as asset owners, particularly in Australia and New Zealand, continue to refine their ESG integration approaches, significant variation exists in their methodologies. Some asset owners adopt a top-down approach, adjusting their capital market assumptions (CMAs) to account for climate risks in their return assumptions. Many others rely on a bottom-up methodology, incorporating sustainability at the asset class or individual investment level. Additionally, debate continues about the trade-offs between impact objectives and traditional risk-adjusted return expectations, as well as other investment objectives that asset allocators must optimise.

Despite growing efforts to integrate ESG information into SAA processes, several challenges persist. Data limitations, methodological complexities, and organisational structures influence the extent to which ESG information can be meaningfully incorporated.

Further, a key finding from our study is that ESG information continues to be viewed largely in the realm of asset class teams and is not the most important determinant of setting long-term investment strategy. This dynamic partly reflects the fact that investment strategy teams and leaders need to juggle many—sometimes competing—objectives, including the incorporation of ESG information. The challenge of managing these competing priorities is an important aspect to monitor and track, especially as asset owners become more sophisticated in strategies that consider ESG information, such as advancing toward decarbonisation targets.

• Asset allocators¹ prioritise financial objectives over environmental, social, and governance within the strategic asset allocation process. ESG factors rarely drive strategic asset allocation decisions and remain secondary to financial performance and regulatory benchmarks.
• Environmental, social, and governance integration at the strategic asset allocation level is informative but not transformative. Asset allocation teams typically employ an ESG integration toolkit that includes climate-aware capital market assumptions, stress testing, and scenario analysis. However, the influence of these tools on SAA settings remains limited, due to the marginal impact on return forecasts and persistent challenges related to data uncertainty.
• Regulation and internal constraints hinder environmental, social, and governance integration. Policies like Australia’s Your Future, Your Super test and competing internal priorities discourage ESG innovation in long-term strategy.
• Environmental, social, and governance integration within asset allocation focuses heavily on climate factors. Social and governance factors remain relatively underdeveloped due to the inherent difficulties in quantifying and integrating them into asset allocation models.
• Environmental, social, and governance integration requires board insights, strategic leadership, and smart regulation. Effective ESG integration requires board directors to understand where the levers of highest impact are, senior management to set deliberate strategies, and regulators to be aware of unintended policy consequences.