ESG fund assets forecast for explosive growth, a huge ILS opportunity

The rapid growth of ESG (environmental, social, governance) appropriate investment products is set to create a “paradigm shift” in investment markets, which could lead to more than 50% of European mutual fund assets invested in ESG funds as soon as 2025, according to PwC.

In a recent report PwC highlights the stunning growth potential of ESG investing, forecasting a base case 21.9% compound annual growth rate (CAGR) from 2019 to 2025 and a best case CAGR of as high as 28.8%.

Those stunning growth projections go some way to explaining the focus in insurance-linked securities (ILS) and reinsurance-linked investments on developing ESG appropriate investment strategies, policies and driving home the features of ILS as an asset class that make it ESG appropriate from the start.

Should the forecast levels of expansion of ESG assets occur and remember this is just in European mutual investment funds, PwC estimates that could equate to between EUR 5.5 trillion and EUR 7.6 trillion of assets under management in ESG compliant funds by 2025.

That’s a potential 357% growth, from the roughly EUR 1.667 trillion of ESG fund assets under management seen today in Europe.

Perhaps even more of interest in the ILS world and for reinsurance markets, is the fact bond investments are expected to grow at the fastest pace, with a CAGR of more than 30% forecast.

This is not just interesting for the alternative or ILS market, given the catastrophe bond is a Rule 144a security with secondary transferability, making it very attractive to major institutions around the world.

But on the traditional market side, the growth of ESG bonds and green bond issues is also both a source of potential financing for insurance and reinsurance firms, as well as an ESG investment opportunity.

So the impending explosion of growth in the ESG investing space will bring benefits to both sides of re/insurance.

But, for the ILS market in particular, the opportunities delivered by this growing wave of interest in ESG investments could drive significant growth potential for the market.

As a result, ESG appropriate catastrophe bonds, that have disaster risk financing mandates, perhaps sovereign in nature, as well as ESG appropriate collateral investment guidelines, could find themselves in significant demand in time, as the ESG wave accelerates and grows.

Ideas such as the way a World Bank Treasury issued catastrophe bond’s proceeds were used by the IBRD to fund sustainable development projects in its member countries show a path towards greater ESG-compatibility for investment strategies in the ILS market.

At the same time, ILS fund managers are implementing ESG focused investment policies, as they try to stay ahead of the wave of investor interest in ESG assets.

While, traditional insurer Generali launched its own framework for Green Insurance Linked Securities earlier this year, which provides further details on ways to make catastrophe bonds an even more ESG appropriate investment opportunity.

PwC calls the ESG asset explosion “the growth opportunity of the century” and highlights four key catalysts for the European investment markets.

First is the regulatory and legislative momentum behind ESG, which is bolstering the attention ESG assets receive and “is likely to have the biggest impact on accelerating the shift to a sustainable model of investing,” PwC says.

Second, the fact many ESG investment strategies have actually outperformed their non-ESG comparatives has heightened interest, particularly in this low-interest rate world.

Third, the shift in societal values towards ESG values, means heightened interest in ESG investments and also some investors beginning to actively shun non-ESG opportunities.

Finally, and for the ILS market perhaps one of the biggest drivers given the core protection products it provides, the “fundamental societal shifts, magnified by current environmental, social and health crises,” which PwC notes has helped to catapult climate change and sustainability to the top of the agenda, accentuating the attractiveness of ESG at this time.

“These catalysts are set to usher in the greatest shift the European Asset and Wealth Management (AWM) industry has ever undergone; presenting managers with the opportunity to drive change by playing a key role in mitigating climate risk,” PwC said.

There it is, “the opportunity to drive change by playing a key role in mitigating climate risk.”

That speaks to the very mandate of the ILS market, as a source of efficient capital that entities can transfer climate, weather and catastrophe related risks to, to reduce their own exposure and remove them from their own balance-sheet.

The ILS market and the investors backing it are already playing a vital role in mitigating climate risk. At the same time, helping to stabilise global insurance and reinsurance markets with their efficient and often lower-cost capacity, providing disaster risk financing and financing to support recovery from severe weather or climate related events, and through its marketplace offering one of the only available transparent pricing mechanisms for climate related perils.

Of course, to really benefit from explosive investor interest in ESG assets, the ILS market needs to clearly demonstrate and answer questions on the topic of adequate pricing for climate change risk. If it does this well, the opportunities are seemingly enormous.

One risk to the growth of ESG assets is how persistent the slowdown in investment markets related to the pandemic turns out to be.

But even here, PwC forecasts a CAGR of roughly 13% for ESG assets under management in Europe, if the market slowdown proves more persistent than currently expected.

ESG is destined to continue becoming increasingly important for the ILS market and given these growth projections it is now surprise that managers in the space are adapting their strategies to help investors understand what ILS as an asset class has to offer, from an ESG standpoint.

One final point. As well as being a huge opportunity for ILS and other asset classes that have ESG characteristics, this is also a huge responsibility as ILS in particular has the ability to create distinct categories of products that are ESG in nature of their protection features and also the returns they deliver.