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The recently published reports from PRI signatories under its Reporting and Assessment Framework offer an unprecedented opportunity to analyze industry trends with regard to the implementation of responsible investment approaches and to identify shared practices and common challenges amongst signatories.
RobecoSAM analysed over 80 asset owners’ reports that were already available on the PRI website in May and presented some preliminary findings to a group of 20 asset owners and investment consultants in London at a private meeting held during the RI Europe conference in June 2014. The analysis focused only on the “indirect investment” module for listed equities, which covers “manager selection, appointment and monitoring”. The sample group used for this analysis was representative of the PRI asset owners’ signatory base in terms of geographical distribution, and it did not present any size bias. Furthermore, according to PRI Secretariat staff familiar with the entire data set, the trends observed in our sample are good reflections of the overall asset owners’ practices. How responsible investment can be incorporated into manager searches is particularly relevant for asset owners because two thirds of them outsource at least 10% of their listed equities investments to external asset managers, while a quarter use external asset managers for more than 50% of their listed equities allocation.
When asked which “ESG incorporation” approach asset owners would encourage or require their external asset managers to apply, 70% indicated “ESG integration”. This compared with 50% and 25% for screening and thematic approaches respectively, confirming that integration is the preferred strategy for mainstreaming responsible investment practices. In fact, 40% of asset owners selected only “ESG integration” in this multiple choice question. Given this stated preference, asset owners are faced with the twin challenge of (1) identifying asset managers that truly integrate ESG in their investment decisions, especially since this may be less visible in their investment processes than in ESG screening or thematic strategies and (2) ensuring these aspects are incorporated in their mainstream asset manager searches and that these expectations are actually implemented in the way the mandates are executed. So what measures are asset owners typically taking to assess the RI capabilities of their asset managers? Which areas are proving particularly challenging? Overall, the data shows that whilst a fair amount is being done at the manager selection stage,less is done in terms of monitoring and ongoing dialogue with asset managers once they are selected.
Manager appointment challenges
A major challenge appears to be the appointment stage, where few RI-related aspects investigated at the selection stages are then translated into the formal contractual agreements. For instance, only 6% of asset owners indicated that they include reporting on RI characteristics of portfolios in the contract clauses with their asset managers. Only one asset owner indicated that it requires reporting on the impact of ESG issues on financial performance. Feedback from asset owner attendees is that part of the challenge of formalizing these requirements into legally binding agreements comes from legal advisers who are not convinced about ESG integration. Besides contractual agreements, the data also suggests that formalizing RI in mainstream manager search processes remains a challenge. For instance, even though more than two thirds of asset owners review managers’ RI policies, assess managers’ abilities to identify and manage ESG issues and discuss the impact of ESG issues on investment decisions at the selection stage, less than 25% of asset owners assign specific weighting to ESG factors in the final asset manager evaluation.
RI in formal evaluation?
Similarly, whilst two thirds of asset owners include responsible investment as a standard agenda item at performance review meetings, less than 40% indicate that a responsible investment criteria is used as a formal component of overall manager performance evaluation. There also appears to be some discrepancies between asset owner goals of assessing asset managers’ investment processes at the selection stage and the concrete measures they employ to fulfill this objective. Two thirds of asset owners indicate that they assess managers’ ESG incorporation strategies, but less than half assess the quality and coverage of the ESG research used by the asset managers or meet with their investment staff to review their RI competences. Less than 15% of them engage with managers on the use of research budgets and how they incentivize brokers to provide ESG research. Given the push from regulators (eg MIFID 2) for transparency about commissions use and asset owner oversight of this, these low percentages suggest the need for early remedial action. Given the growing demand for “ESG integration” in investment strategies, these challenges are likely to intensify. As asset managers become more sophisticated and consider ESG issues as part of
standard (albeit enhanced) fundamental analysis, using different sources of data (including information found in integrated reports) and feeding these seamlessly into their valuation models and investment decisions, it will become more difficult to isolate the “ESG component” of the investment process. However, ensuring that this is truly part of the investment philosophy of the asset manager and part of the skills and competencies of all investment staff will assume a greater role in the manager search process. As Kepler Chevreux have noted in their report “Soft Law Violation & Liability” there are growing risks to investors from NGOs and media who criticise “greenwashing”. One way to manage this would be a proactive system for ensuring that integration that is promised is being delivered.
Finally, the challenge of identifying good RI practices in the context of passive strategies came up in the discussions with asset owners at the seminar in London at the RI Europe 2014 conference. The PRI reporting framework focuses primarily on actively managed strategies, but given the growing demand for passive strategies this is emerging as an important consideration for asset owners. When asked which “ESG incorporation” strategies asset owners would encourage or require their external asset managers to apply for passive investment, screening approaches were most often cited, but by only 45% of asset owners.Interestingly, 30% indicated that they would favour “ESG integration” approaches. This is typically associated with actively managed strategies, but in the context of passive strategies it is defined by the PRI as “weighted ESG indices” in which constituents’ securities weights take into account the ESG characteristics of the company or the country. However, less than a quarter of asset owners invested in passive strategies via external managers indicated that they assess the index providers’ ESG incorporation when designing the index.
Long way to go
In conclusion, while the aspirations are clear and ESG integration seems high on the agenda of PRI signatories, implementation remains a challenge in the context of manager selection, especially at the contracting and monitoring stages. And, as we were reminded by the investment consultants participating in the discussion, these findings represent the practices of the most committed and most advanced asset owners. For much of the pension fund industry, there is still a long way to go on responsible investment. This perhaps explains why fund managers report, in aggregate, that the signals coming from asset owners on ESG issues are still weak.
Cecile Churet is Sustainability Investing Client Specialist at RobecoSAM.
RI is holding its annual ESG in Manager Selection and Monitoring seminars in London on October 8 and New York on October 21 Click here for further information