Prius Partners, the ‘fintech’ ESG manager selection specialist unexpectedly closed its doors this week despite having won plaudits from the likes of the UK’s Environment Agency Pension Fund and Sweden’s AP1 state fund. In announcing the closure, company principals Pierre Lenders, Joseph Naayem and Nikolaos Dimakis spoke of being at the mercy of “institutional inertia” in an email blast to their contacts. With their permission, RI publishes their comments in full:
Despite many declarations of intent, integrating ESG concerns within mainstream portfolio management is happening rather slowly. Because of its origins, ESG remains mostly a matter of compliance and labels. It is an explicit, integrated part of investment policy only within SRI allocations, and further progress from here depends on ESG proponents’ ability to demonstrate that it is not just there to satisfy some ethical agenda but that it also works financially. Therefore a prerequisite for a larger scale impact is a valid framework to conduct such assessment, encompassing products which are not explicitly SRI labelled. And asset owners need user friendly and reliable tools to help them ascertain how effectively asset managers proceed to integrate ESG across any of their products. Such tools, we believe, should not be “coffee for everybody” but allow starting from the asset owners’ concerns and preferences. They should answer two separate sets of questions about the investment style of managers or passive solutions under consideration, in just a few comprehensive dashboards and indicators:
• Is enough attention paid to the ESG factors that are deemed to matter? Is there a preference for companies that already behave well on specific factors, or for companies improving their behaviour on others, or is there no evidence of any of such two biases? (independently from financial performance)
• Is there an acceptable rate of avoiding financial losses related to bad or deteriorating E, S and/or G behaviours, and/or enough evidence of being able to benefit financially from positive or improving ESG behaviours, at least along material factors?
As evidenced by the choice of topic for the “great debate” at the upcoming June RI Europe conference, this issue is now coming to the forefront. Ranking and rating of all mainstream funds based on ESG metrics might indeed help, or make the problem worse if left to dogmatism, unduly homogeneous and backward looking calculations. We believe it will all depend on how credible and sound the framework will be in the eyes of the mainstream community, and what will be said about how ESG factors interact with security prices will need to make perfect financial sense to them as investment professionals, and not just from a marketing angle. Ordering investment professionals to comply with backward looking, lagging indicators is the surest way of antagonizing them as they will claim that such policy would prevent them from doing what they should be paid for: anticipate which company will soon be recognized as having improved, and stay away from companies that might have great reputation but which are accidents waiting to happen. Witness a study by NNIP which came out just few days ago and which indicates that simplistic ESG implementation might end up counter-productive.
We suggested an objective framework for such double assessment, built on two innovative pillars:
• A forward looking approach
To realistically model how ESG links to financial performance, we thought one should focus also on behavioural improvement, not just on static compliance. We were pleased to meet a growing interest from asset owners and asset managers alike sharing the simple but powerful idea that whilst investing in well behaving companies has merits, investing alongside companies experiencing behavioural improvement might be even better in maximizing societal and financial impact simultaneously.
• A quantitative angle
Now that hard facts about investment styles can be collected with just enough historical depth, and that statistically significant information can emerge from scrutinizing all past investment decisions, one can back check and/or question the ESG portions of narratives and self-promotional documents with the benefit of hindsight. We are certainly grateful to Sustainalytics for having let us access their granular historical dataset. This made possible to showcase a full scale implementation of our framework.
Three years later…
We developed over time a comprehensive web based technology (FLAME & ASAP), picking up on many of your feedbacks. Deliberately ignoring labels and stated intentions, agnostic to rating datasets being used, it leveraged on historical portfolios and factor data to provide quantitative insights around the above two key dimensions: is the manager style exhibiting a preference for behavioural improvement among companies in portfolio (i.e. how often was the ESG gradient positive?), and how did this precisely relate to risks, gains and losses (i.e. how much was value creation aligned with correctly analysing ESG dynamics before they translated into rating changes?).
As we witnessed the industry’s growing awareness that engaging and fostering behavioural improvement (the “washing machine”) is the best answer to the infamously puzzling sin stock paradox, it seemed we had a solution to a real problem. We were initially encouraged to constantly hear that we were “in line with where the industry is heading, just 5 years ahead of the curve”. But three years later, that is still where we hear we are. As promising as it sounds, this is more a curse than a blessing for a self-funded start-up at the mercy of institutional inertia. Recognizing we were not able to get the business off the ground quickly enough, we came to the decision to call it off and look for better ways of deploying what we learnt.