“Do we take responsible investing to the next level or do we let responsible investing be the excuse for our industry?” This question was asked from the audience at a conference earlier this year. And to an extent, I would agree with what I believe is the implied answer to the question. For some asset managers, responsible investing is nothing more than a useful marketing tool and an excuse to continue what they are doing with no change. This article argues it is time to take a critical look in the mirror, ask what responsible investing is truly about, and up the ante.
Is responsible investing a success?
Or is it becoming a victim of its own success? Let’s first have a look at the success. After its launch about eight years ago, the United Nations-supported Principles for Responsible Investing (UNPRI) now has well over 1,200 signatories representing $34 trillion in assets under management. These are staggering numbers that should be viewed as an enormous success for the uptake of what the UNPRI initiative stands for and the good work it has been able to accomplish. The numbers reported by the Global Sustainable Investment Alliance (GSIA) are also impressive. The GSIA finds that “globally at least US$ 13.6 trillion worth of professionally managed assets incorporate environmental, social and governance (ESG) concerns into their investment selection and management” which now “represents 21.8 percent of the total assets managed professionally in the regions covered by the report”.
But are the numbers real?
Analysis shows the numbers might be somewhat inflated. First, less than a quarter of the signatories to the UNPRI are asset owners, while asset managers make up the vast majority. Second, there is probably some double counting, e.g. both asset owner (client) and asset manager (agent) count the ‘same’ assets twice as responsibly managed. Or worse, triple counting may occur if an asset owner has hired a fiduciary manager that selects third parties for the management of the assets.Third, asset managers can claim to be responsible investors by signing the principles and applying them to just a minority part of their asset base. Typically, this will be the case for asset managers that have signed the UNPRI because their clients asked for it. Such managers have generally chosen to apply the principles to a limited number of funds and mandates, particularly for European retail and institutional clients, while the management for the majority of the assets for clients outside Europe remains unchanged. Yes, there is, and should be, room for ‘aspiration’ in rewarding good intentions, and leaving time and room for development and implementation. But for some signatories it is hard to see that there is a true effort to implement the principles any further, for example to commit to a 90% integration level in 2020. However, representativeness of the numbers, a lack of true intention, and potential double counting are not the most serious issue here. The bigger question is what do these numbers actually represent? Taking a closer look, there are typically three major responsible investing strategies: ESG integration, corporate engagement and negative screening (or exclusion). Although these strategies have the potential to truly contribute to what responsible investing should be about, for the majority it probably is not the case today.
ESG integration: hitting the target but missing the point
Let’s start with looking at ESG integration, the first UNPRI Principle. ESG will only live up to its full potential when it is applied for the right purpose. That’s mostly not the case today. Typically this means that non-financial information is taken into account to formulate improved investment analysis and make better investment decisions. However, the common definition of ‘better’ remains unchanged in our industry and is solely defined as a better financial risk-return profile. Positive change remains a ‘means’, not the ‘ends’ of ESG integration. Also, a one-dimensional purpose such as financial return leads to sub-optimal allocation of capital, both for investors as well as for companies.
It is time to look at multiple, balanced purposes of investing beyond just financial metrics. Frameworks like integrated reporting provide a very promising concept for investors to use and to apply the concept to their own reporting.
Corporate engagement: delivering already and promising for more
The second UNPRI Principle is about active ownership, also called corporate engagement. This is mostly applied for the purpose of positive change by influencing companies via constructive dialogue. According to anecdotal evidence, engagement has led to a positive influence in the real economy, and, according to the few academic studies that have been made, yielded positive investment returns. It’s a win–win, one could say. Engagement has grown in acceptance over the past decade and if applied rightfully it can be a very important tool for responsible investing. However, engagement strategies are mostly applied after investment decisions have been made. Engagement could be a more powerful instrument if it influenced the investment process more directly, either via a feedback or pre-investment mechanism. The latter would signal integration beyond ESG risk factors and towards the potential to influence the investment decisions more directly. Although this development would be welcome, in the end it comes down to balancing the engagement insight and financial return expectations. As long as financial return is the sole, one-dimensional purpose of investing, it is likely that a financially promising investment is made anyway and that engagement at best will be started simultaneously. The real question is the purpose of investing. Is it to maximize financial return or to also generate broader positive change?
Exclusions – proof of the pudding is in the eating
As opposed to ESG integration and active ownership, exclusion is not mentioned in the UNPRI Principles. There is a connection, however, through engagement on severe issues, such as breaching minimum standards of the UN Global Compact, which can for some institutional investors lead to the exclusion of a company if it fails to adhere to preset minimum targets.Although this practice is applied more and more – predominantly in Europe – it remains a paper tiger. With the exception of a leading minority of asset owners, most exclusion lists are short, generally no more than a dozen,and affect a limited part of an asset manager’s business. Few mainstream institutional investors have exclusions lists above 50 or 100 names. Are the remaining thousands of companies still under engagement, facing potential exclusion, or making a positive contribution to sustainable development, or at least not getting in the way of it? It will be interesting to see how exclusion lists and the scope of their application develop over time as an indication of true commitment to responsible investing.
Taking it to the next level
While there are successes to cheer, the true uptake of responsible investing is still lacking. It has been eight years since the launch of the UNPRI and it is time for a new, even more powerful impulse. It is time to introduce other goals for investing alongside pure financial metrics. Integrated reporting for companies and institutional investors themselves is a promising path forward. Acting as a strategic ‘steering’ group on broad value creation (combining finance and social/environment benefits), could keep responsible investing from becoming complacent. Today many investors continue to invest in ways where the long-term impact on the real economy is unclear and unmanaged. Even though transparency and accountability are increasing, also in our industry, we are still a long way from the point where the ultimate beneficiary can get more insight and say in how his or her money is put to work.
It is time that responsible investing really starts to affect investment decisions in a holistic, integrated and credible way.
Erik Breen is part of the Socially Responsible Investing (SRI) team at Triodos Investment Management with a focus on product innovation.