Only 9% of more than 5,000 investment strategies achieved the highest environmental, social and governance (ESG) ratings, according to an analysis performed by Mercer’s investments business: See separate RI story Since 2008, Mercer has been assigning ESG ratings to investment strategies that span asset classes and geographic regions. Although not news to people within the RI sector, this welcome public comment from an organisation with Mercer’s credibility is another helpful wake-up call for UNPRI members, not least because PRI’s principle number 1 states “We will incorporate ESG issues into investment analysis and decision-making processes.” Will Oulton, European head of responsible investment, told the FT that faced with such poor results, “trustees are likely to challenge fund managers to do better on ESG issues in the future. We are seeing trustees question fund managers more closely on this in the selection process.” So on whom/what should asset owners focus? My top 3 recommendations are mandate design, the mainstream research supply chain and mainstream investment consultants.
1. Integrating ESG factors into mandate design: Better monitoring is welcome but you can only monitor something well when you have asked for it properly. Simply bolting on ESG integration to the normal mandates won’t work: rather the mandate should be re-considered as a whole. One example of this is asking active managers to take a more fundamental approach but then being disinterested when churn rates are much higher than promised, as Mercers themselves have earlier shown is often the case: Link
The ICGN’s “Model Mandate” project is a good first step, and it needs to be combined with mandatory reporting on the part of asset owners for it to have real impact – the opportunities for “SRIwash” are otherwise too great. If ICGN and UNPRI took a muscular approach to this matter, enhanced voluntary reporting might yet trigger a race to top and pre-empt regulatory action and or an #OccupyPensions movement: Link. Making the mainstream research supply part of the solution: With exceptions that prove the rule, sell side and credit rating agencies are today a big part of the problem in terms of ESG integration, in particular with regard to high-impact low probability events where the assumption is that costs will be externalised. Until ESG integration enters the mind-sets and models of these powerful information intermediaries, there is little hope that the buy side will systematically take ESG into account in buy/sell valuations, even in stewardship decisions. Although this has been known for some time Link it has also been largely ignored (the culture change challenges are often troublesome and there is not enough client demand to warrant management time). The BP Macondo case is a painful but helpful reminder of the sometimes catastrophic costs of this failure http://bit.ly/nqaivG but it should also be remembered that value destruction probably on an even greater scale is happening below the water line Link
Responsibility for this rather sorry state of affairs rests with the direct clients (fund managers) and their own clients (asset owners). Building on the learning of the successful Enhanced Analytics Initiative, now is a good time for the Board of PRI to accept its accountability in this regard and announce the launch of a new collaborative project which will progressively shift the research supply chain. Such practical leadership would show that the organisation really understands that the “honeymoon is over” as Chairman Wolfgang Engshuber has said. Since PRI now accounts for 10-15% of the market, this is a very reasonable target and would go a long way to answer the question: “so what exactly has PRI achieved?” PRI (with $30 trillion and a global profile, with big US signatories of late) should be aiming to achieve significantly greater impact with regards to ESG integration by the sell-side than the much smaller and EU focused EAI project ($1-2 trillion). This has not been the reality to-date, with prominent firms like Deutsche Bank and JPMorgan discontinuing their work in this space. Of
course, other investor trade bodies (CERES/INCR, ACSI, ABI, etc) needn’t wait for PRI, but the bottom line is clear: if business as usual continues and there is only further incremental change in the mainstream research supply chain, the next Mercers report on ESG integration will be an entirely predictable surprise.
3. A similar study focused on “coal face” investment consultants: This work by Mercers is greatly welcome and it highlights the value of a similar study looking atwhether and how the mainstream investment consultants – who are often critical gatekeepers – are integrating ESG into their advice, not just in terms of fund manager selection but also investment beliefs, ALM, risk management (ie higher level, top down, investment decisions).
Raj Thamotheram is an Independent Strategic Adviser, Investment at Raj Thamotheram Associates
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