How can investors balance short-term demands with long-term value?

As their widespread use of ESG information indicates, investors do acknowledge the economic and political importance of sustainability. They also understand that long-term value is generated by companies transitioning to more sustainable business models. Nevertheless, immediate macroeconomic and geopolitical pressures mean that their investment decision-making is still often geared toward short-term objectives.

Nearly two-thirds (63%) of investors surveyed say that shifts in the business cycle — including periods of slower economic growthand recession — is the factor that will most acutely or substantially affect their institution’s investment strategy over the next two years. In terms of core macroeconomic factors that might impact economic performance and the business cycle, investors are most likely to monitor trade restrictions and tariffs (62%), cost of capital (53%), and labor cost and availability (50%).

Yet, while economic concerns appear to be their primary focus, investors say they are also prioritizing sustainability. In fact, the majority of investors surveyed (55%) state that the impact of climate change will acutely or substantially affect their investment strategies in the near term. Investors in Europe and North America are far more likely than their peers in other parts of the world to see climate change as a driver of investment strategies. This correlates with the maturity of those markets in terms of regulation and policy relating to climate change.  

Along with short-term pressures, another factor that may be contributing to the say-do gap is that investors don’t necessarily trust the information being provided to them by companies. Therefore, they are cautious about allocating capital to businesses claiming sustainability credentials.  

More than four out of five investors surveyed for the research (85%) say that greenwashing and similarly misleading statements about companies’ sustainability performance is a greater problem compared with five years ago. This is a troubling finding, leaving us to wonder whether investor confidence in corporate sustainability information will increase as more jurisdictions move to mandatory, assured sustainability disclosures — and with reporting and sustainability standards continuing to evolve.

Investors’ current concerns about greenwashing appear to be validated by the 2024 EY Global Corporate Reporting Survey, which found that companies have doubts about the credibility of their nonfinancial reporting. More than half (55%) of finance leaders surveyed for that study felt that sustainability reporting in their industry risks being perceived as including elements of greenwashing.

Given their lack of confidence in the ESG information being provided to them, it’s surprising that 93% of investors surveyed for this report say they are confident that companies will meet their targets for sustainability and decarbonization. This puzzle is compounded by EY research suggesting that companies are, in fact, struggling to meet their goals. The 2024 EY Global Corporate Reporting Survey found that fewer than half (47%) of finance leaders think it’s very likely that their organization will deliver against its major sustainability priorities and meet stated targets, such as achieving net zero on time. 

The disconnect between investors’ confidence in targets and what companies themselves are saying could be attributable to one of several factors. It could suggest wishful thinking on the part of investors or that investors are not actively tracking companies’ progress against their targets. It is more likely, however, that investors are monitoring what companies say on sustainability but expect them to switch to more achievable targets over time. 

To protect their capital and effectively manage their risks, investors should encourage their investee companies to publish a transition plan and disclose their financial commitment to transition activities. The EY Global Climate Action Barometer 2024 found that only 41% of companies had adopted a transition plan for climate change mitigation. Furthermore, regardless of whether they had a transition plan or not, just 17% had disclosed capital expenses (capex) in relation to climate initiatives and only 4% had disclosed operating expenses (opex).

Voting for change

The investors surveyed say that they consistently support ESG shareholder resolutions, with 86% confirming that their recent voting record had been to generally vote in favor. Political or social pressure on ESG matters is the factor most likely to have influenced investors’ voting on ESG and sustainability-related shareholder solutions (with 39% saying this had a substantial impact). That result was very nearly matched by outcomes from prior ESG and sustainability-related initiatives (38%).

Interestingly, however, the survey findings do not align with wider data that points to much lower levels of support from institutional investors for ESG-related shareholder solutions. This may be another example of the say-do gap. For instance, data from the Principles for Responsible Investment (PRI) reveals that average levels of support for shareholder resolutions fell from 28.3% in 2023 to 21.6% this year. According to the PRI, there are a couple of reasons for this downward trend. The first is that shareholders believe that certain resolutions are overly demanding for companies to implement, which leads to them being withdrawn. The second is anti-ESG sentiment, which has resulted in some shareholders either filing anti-ESG resolutions or not supporting pro-ESG resolutions.³

Furthermore, the survey indicates some skepticism among investors around the potential for ESG and sustainability resolutions to have a long-term impact on shareholder value. Only 26% say that the resolutions’ potential to drive long-term value had substantially influenced their firm’s voting. Even fewer (10%) state that their firm’s voting record had been driven by the belief that the resolutions would impact near-term profitability.

Overall, the survey suggests that investors see “outside-in” macro information as more meaningful than company-specific disclosures. Just 17% monitor shifts in climate-related policies by companies, implying that corporate reporting as it stands may not be giving investors the insights they need to inform their high-level decision-making. 

Climate litigation

Investors also are monitoring the risk of climate litigation. There has been a rise in cases launched against companies and governments, typically by well-funded lobbying and activist groups. Some of these cases challenge companies and governments for not taking enough action on climate. Others come at the issue from a different angle — for example, ESG backlash cases that challenge the incorporation of climate risk into financial decision-making. Among other types of case, there are “green versus green” cases focused on potential trade-offs between climate and biodiversity or other environmental aims. 

Climate litigation is not just a risk because it is costly and time-consuming. Regardless of whether a lawsuit is won or lost, it can damage a company’s reputation and potentially undermine its standing with customers, regulators and society at large, with far-reaching implications for its business model. This, in turn, can impair the value of an investor’s stake in the business. 

Acutely conscious of the risks posed by climate litigation, investors are carefully scrutinizing their exposure. Nearly half (49%) of those surveyed undertake structured reviews of climate-related litigation risk against their firm by clients or stakeholders, while 40% undertake an ad hoc review. Similarly, 49% of investors say their institution undertakes a structured review of climate-related litigation risk against the companies it invests in, with 38% carrying out an ad hoc review.

Investors can access a wealth of sustainability information thanks to the plethora of initiatives and frameworks that have been launched since the Global Reporting Initiative began in 1997. Additional information will become available as companies increasingly report under the International Sustainability Standards Board (ISSB) disclosure framework and the EU’s Corporate Sustainability Reporting Directive (CSRD). The CSRD requires entities to report sustainability information under the reporting framework of the European Sustainability Reporting Standards (ESRS), approved by the European Commission in 2023.

Yet, despite the expected future growth in sustainability reporting, it seems that investors are not currently getting decision-useful information. Over a third of those surveyed (36%) are dissatisfied with the progress made by companies in delivering new nonfinancial performance reporting. What’s more, investors are most disappointed in the materiality, comparability and accuracy of sustainability data. Four out of five investors surveyed (80%) believe that the materiality and comparability of sustainability reporting need improvement, with 62% saying the same for accuracy. 

Many of the improvements that investors are looking for in terms of materiality, comparability and accuracy may be seen as the ISSB and ESRS frameworks are implemented in practice. Nevertheless, it’s early days for both. The IFRS Sustainability Disclosure Standards came into effect in 2024, while the first companies to report under the CSRD will report in 2025 on 2024 data. As the benefits of the frameworks become clearer to investors, they should become more confident about the quality of companies’ sustainability reporting, which will help to close the say-do gap. 

For now, however, investors still have mixed views on the likely usefulness of the CSRD and ISSB. They believe that the ISSB standards are better articulated to investors and companies, which is likely a reflection of the “financial materiality”-focused nature of the ISSB standards. In addition to financial materiality, the CSRD requires an “impact materiality” lens to be applied. Nevertheless, there’s a perception that while both ISSB and ESRS are suited to support long-term investment decision-making (which is what they are designed for), they are far less suited to supporting short-term investment decision-making. This is a challenge for investors who understand the importance of investing for the long term but have their performance measured on a quarterly basis — a situation that exacerbates, motivates and even incentivizes the say-do gap. Furthermore, less than a third (29%) of investors think the ESRS reporting standards are sufficiently detailed and complete for investment decision-making, while 22% say the same of the ISSB standards. 

In many cases, information reported under the CSRD must be independently assured by a third party. While the ISSB standards are intended to generate assurance-ready information, those implementing them will determine whether they require assurance. Investors certainly see the benefit of assurance in terms of improving the quality of information provided by companies. Nearly two-thirds (64%) of those surveyed agree that ISSB and CSRD reporting should be independently audited.

Assessment of nonfinancial performance information

Investors are generally confident in their abilities to assess companies’ sustainability-related disclosures. More than two-thirds (68%) of surveyed investors feel very well or adequately equipped to assess information relating to the ESG practices of supply chains, while 62% say the same for climate-related information. 

Investors are, however, much more confident about evaluating the short-term impacts of ESG policies and performance compared with the long-term impacts. This is likely because of the variables and unknowns that can make it difficult to model long-term risks and outcomes.

It is not clear from the survey whether the say-do gap between what investors say about integrating sustainability into their decision-making and what they do in practice is likely to narrow — or widen further — in the near future.  

On the one hand, investors are showing some signs of “sustainability fatigue” and recognizing the difficulties involved with quantifying and selling the ESG benefits of long-term value creation where short-term corporate performance is not strong. On the other hand, they continue to engage with sustainability at a meaningful level. They are also developing a deeper understanding of sustainability, as both a risk and a value driver for their portfolios, so they can price it into their investment strategies. 

The reality is that investors are often in different places in their own maturity, depending on the market in which they invest. Some investors — particularly in Europe — are actively holding companies to account over issues such as targets and remuneration. In the US, however, investors have grown more cautious. They have faced an anti-ESG backlash that has resulted in some pension funds being sued for breaching their fiduciary duties when considering ESG-related risks in investment decision-making. Additionally, there is uncertainty about the effects of an administration change in January. However, based on the 2016-2020 experience, we observed that investors continued to focus on ESG as an investment risk despite the political environment, and it is anticipated this trend will likely persist.

Nevertheless, the global direction of travel remains unchanged; the world’s biggest markets still have ambitious net-zero targets in place. China wants to reach carbon neutrality before 2060, for example, while the EU and the US are both targeting net zero by 2050. Meeting these targets will require governments to launch major infrastructure projects and companies to develop new, sustainability-oriented business models. In turn, the real-economy link between sustainability and competitiveness will likely begin to emerge as a positive investment strategy. The financial losses associated with extreme weather events — which are only likely to increase in frequency and intensity — will encourage investors to maintain their focus on sustainability, at least when it comes to climate. Climate risk is likely to be one of the biggest disruptions facing companies over the next 20 to 30 years. 

Meanwhile, the economic risks associated with nature are becoming far more widely understood, increasing the pressure on companies to act quickly to address them. In fact, research by the University of Oxford has predicted that shocks to the global economy related to biodiversity loss and ecosystem damage could cost upwards of US$5 trillion.⁷ Given these challenges, it makes sense that one investor interviewed for the study described the current hiatus on the part of investors as “a temporary blip.”

Going forward, a sustainable investment strategy will require investors to integrate sustainability broadly into their whole portfolio rather than confine sustainability investing to a small set of characteristics and companies. As a result, investors will need the capacity to measure investment risk more accurately and the mindset to proactively seek out better investment opportunities.

Additionally, the “Great Wealth Transfer” ⁸ (the intergenerational shift of wealth) has begun. As this shift takes hold, a new generation of more sustainability-motivated asset owners will likely be seeking sustainability outcomes alongside financial returns. Investors who are not prepared for this transition, with appropriate investment strategies and track records, are likely to be left behind.

Already, asset managers recognize that their clients are demanding sustainable investment products and they are actively trying to meet that demand. Over three-quarters (77%) of asset managers surveyed say they have increased their focus on the development of ESG-related investment products, including mutual funds and exchange-traded funds. A similar percentage (74%) note that client interest in ESG-related investment products had either substantially or somewhat increased over the past year.

Closing the say-do gap is expected to result in more capital being allocated to organizations that make a positive difference over the long term. Additionally, it will allow sustainability to be recognized for what it is — not just a portfolio risk but, equally importantly, a major value driver of investment strategies.  

So how can we close the gap? These recommendations for investors and companies can help to build confidence in sustainability as a driver of long-term value, support the achievement of targets and accelerate the transition to a net-zero economy:  

Investors should

Companies should

Summary

The investment risks and opportunities posed by climate change and sustainability have far-reaching implications for companies and their business models. As a result, investors should view them as an integral part of their investment strategy rather than a niche application to a subset of mandates and products. Through this approach, they should be able to succeed in balancing short-term demands with long-term value and close the say-do gap.