Following up on our initial piece on ESG in asset manager selection in Responsible Investor in July, we continued our analysis of PRI signatories’ data and looked at whether current practices in terms of ESG integration and active ownership live up to asset owners’ growing expectations. Here again we found some discrepancies between aspiration and implementation and identified some opportunities to close this gap.
Supply and demand
Our analysis of over 80 asset owners’ PRI reports back in July revealed that “ESG integration” was their preferred strategy, followed by screening and to a lesser extent thematic investments. Looking at additional data, it seems at first sight that supply broadly matches demand. Our review of 40 European asset managers’ PRI reports indicated that two third of them applied a combination of screening and integration approaches to about 40% of their listed equity assets under management (AUM) on average. This was by far the most popular approach. In addition, one third of asset managers also reported that they exclusively applied an ESG integration approach in, on average, about 30% of their listed equity AUM. This makes ESG integration (alone or in combination with screening) the most common “ESG incorporation” approach; a good sign for the “mainstreaming” advocates.
ESG integration in practice?
However, a closer look at the data reveals that sophisticated ESG integration is far from common practice, even amongst the most committed PRI signatories. Within the context of actively managed listed equities, we at RobecoSAM see “ESG integration” as a process that includes the following characteristics: (1) the analysis of ESG data is produced by internal investment teams to form their own opinion of corporate sustainability performance and how it contributes to long-term competitiveness and financial performance) and (2) this analysis is systematically embedded in fundamental analysis and valuation models .
Yet the data shows that the majority of asset managers use company ratings produced by ESG research providers or specialist teams, while less than 20% of asset managers’ internal investment teams work with raw ESG data. This suggests that ESG knowledge still primarily resides with specialist teams (internal or external) and has not yet been mainstreamed as a core competence amongst investment analysts. Furthermore, when asked at which stage of the investment process ESG information is used, most asset managers indicate that it informs their views of corporate strategy and quality of management, rather than provide direct input into fundamental analysis and fair value calculations. Finally, only 20% indicated that they incorporate this information systematically in the investment process, suggesting that this has not yet become part of investment process discipline.Enhanced financial analysis
Clearly additional training is required to help bridge this knowledge gap. This need was identified recently in the PRI 2014 Progress Report and the PRI’s acquisition of the RI Academy as part of its strategic plan. We are pleased to see this learning tool become part of the PRI’s implementation support toolkit to signatories given RobecoSAM’s contribution to development of the Enhanced Financial Analysis module. We firmly believe such education tools can help improve good practices across the industry by giving asset owners practical guidance on what to expect from their asset managers and enable them to ask concrete questions during their due diligence on how integrated analysis is done in practice.
Integrated asset manager reporting
Beyond helping asset owners at the asset manager selection stage, we also see a need for enhanced reporting on the impact of ESG integration on portfolio characteristics and financial performance for ongoing asset manager monitoring. The PRI data reveals that only a handful of asset owners request this type of information as part of their contractual agreements with asset managers (only 10% of asset owners do so according to the PRI 2014 Progress Report). In the absence of such “integrated reports”, it might not be surprising that less than 20% of asset owners believe that ESG integration actually impacts funds’ financial performance .
Furthermore, our analysis of the PRI data also suggests that only about 10% of asset owners see evidence of impact from engagement activities in terms of improved corporate practices, and very few require information about the way engagement activities impact investment decisions. The link between engagement and investment is still broadly missing. Enhanced reporting can therefore play an important role in closing the gap between investment philosophy, implementation in the investment processes, portfolio construction, engagement activities and investment results. With that in mind, we are increasingly leveraging our sustainability expertise to provide monitoring and reporting tools that enhance portfolio analytics of sustainability and financial performance.
Mind the gap
Overall, this additional analysis of the PRI data supports our earlier conclusion that an important gap still exists between aspirations and implementation, both on the asset owner and asset manager sides. Whilst this may be disheartening in some ways, on the positive side this extensive PRI data set provides for the first time a useful baseline to help identify critical gaps, as outlined here. This baseline enables us to collectively take stock and will no doubt support the development of tools and processes that address these gaps, thereby contributing to moving the industry forward and taking us one step closer to the holy grail of truly mainstreaming sustainability investing.
Cecile Churet is Sustainability Investing Client Specialist at RobecoSAM