Alignment – a term that gets used (or arguably abused) a lot in responsible investment (RI). Company boards need to be “aligned” with the long-term interests of their shareholders. Asset managers need to be “aligned” with the long-term interests of their asset owner clients. Situated near the top of the investment chain, asset owners seem to be in the enviable position of setting the tone from the “demand-side” and encouraging investment intermediaries to tow the responsible investment line.
But what about the asset owners themselves? To what degree are they aligned in their expectations of what they want of asset managers? It has been noted in the past that while a fair amount of effort on RI was going into the manager selection stage, in RFPs in particular, less was being done in terms of monitoring and ongoing dialogue with asset managers once they were selected. (1)
However, the tide may be turning – a group of UK pension funds (2) with over £200bn of assets has been working together to produce a guide on responsible investment reporting in listed equity. Launched today, the guide aims to clearly outline their expectations as to the future direction of reporting for listed equities to provide managers with a clearer picture of what they want to read and hear about when it comes to environmental, social and governance (ESG) integration, effective stewardship and most importantly, getting a better understanding of how these are contributing to improved long-term risk adjusted returns. It should be seen in the context of the group’s wider efforts to include responsible investment in requests for proposals (RFPs), manager searches, due diligence and investment mandate terms.
Three of the guide’s architects, Leanne Clements of West Midlands Pension Fund, Faith Ward of the Environment Agency Pension Fund and Daniel Ingram of the BT Pension Scheme, outline the thinking behind the initiative.
Q: Can you give some insight into the journey that led this coalition to the creation of this guide?
Leanne Clements: In our initial workshop, we started by asking ourselves how we can best move conversations with fund managers away from short-term price and benchmark related risks toward dialogue about what ESG factors could lead to long-term value creation or destruction. Our conclusion was that seeking improved RI reporting – currently not fit for purpose – was the most effective means to achieve that ultimate medium to long-term objective. This represented the starting point of our journey.
Faith Ward: We also recognized that some degree of broad alignment was required within the asset owner community as to what type of reporting we required from our fund managers. In the past, fund managers had indicated to the group that when we did ask for information, it tended to be in an ad-hoc manner and we tended to ask for different things. They also told us they didn’t know what specifically what type of information we required, in what form we’d prefer it and what we planned to use it for.
Daniel Ingram: Over the course of the summer and autumn we also sought feedback from fund managers and other stakeholders in order to refine and improve the guide for its intended primary audience. While we wanted to ensure that our guide was first and foremost progressive, we also wanted to ensure that it was rooted in practicality.Q: You say that the current RI reporting is not fit for purpose. In the group’s view, can you tell me how RI reporting needs to improve and why?
Faith: The end game here is getting a better understanding of how ESG risks are contributing to improved long-term risk adjusted returns. To support this objective, we believe that communication is key to establishing long-term relationships, and the latter is key to financial performance. We believe that this guide provides an excellent tool to make real progress in investment reporting.
Leanne: A lot of RI reporting from fund managers simply includes a distinct section copied and pasted in of research or activity reports directly from an in-house RI team or a third party ESG data or stewardship provider. Only where these insights are clearly integrated in the reporting is it clear that these long-term risk factors have also been appropriately integrated into the investment process. Otherwise, the status quo reporting can cast doubt as to the degree of commitment on RI from the top. We are of course mindful of the NAPF’s Stewardship Disclosure Framework or the UN-backed Principles for Responsible Investment (PRI) reporting requirements. While these frameworks provide guidance for reporting at the firm-wide level, this guide is intended for individual mandates.
Daniel: We acknowledge that the focus could extend beyond reporting on responsible investment and indeed where this is fully integrated there may be limited differentiation. There is a challenge to the industry to develop reporting metrics that are better aligned to long term investing and we defer to work already underway which looks at key performance indicators and improving wider fund management reporting (3).
Q: Can you give more detail about the guide’s contents? How are you expecting fund managers to meet these expectations more broadly?
Leanne: We have divided RI reporting into two interconnected areas. The first is ESG integration: the transparent processes for considering ESG factors in the fund manager’s investment process including examples. This can be further divided in to ESG risk and opportunity identification, followed by management and monitoring. We expect ESG integration to be applied in different ways depending on the fund manager’s investment style. The second is stewardship: the policies and processes for identifying companies for engagement and for voting stocks; voting and engagement activities, and evidence of outcomes from those activities. Broadly, stewardship reporting should make clear how voting and engagement activities are linked with each other, and in turn, how the stewardship and investment functions (including ESG integration) are connected in order to enhance value.
Faith: We cannot emphasize enough that we do not expect all of our managers to demonstrate best practice reporting from day on. However, having said that, all managers should demonstrate a willingness to improve over time. It is that progress – on reporting – that we will be tracking.
Q: Might fund managers interpret this guide as additional reporting burden or cost, especially PRI signatories already having a yearly reporting requirement on RI activities? Can you address this point and clarify what the group means by reporting?
Faith: We have used word reporting in its widest context to capture all forms of dialogue between asset owner and those who are accountable for managing the assets and delivering the mandate. To this end we are including everything from quarterly reporting, annual client and public reporting to ad hoc alerts, updates and verbal discussions reviewing the mandate.
Daniel: It is often the oral updates that provide the most valuable insights into manager thinking and where a more frank discussion takes place freed from the constraints of a written report. A good example of this would be where a manager reflecting on the previous year, identifies not only what worked well, but mistakes and lesson learnt.
Leanne: We have been incredibly mindful to not cause confusion or add to perceived reporting burden through aligning the expectations and metrics with measures used by the PRI (4). We would fully anticipate a manager could directly use much of the material reported to client to evidence progress against the Principles where they are a signatory. However, this guide is not predicated on managers being PRI signatories.Q: How can interested parties get a copy of this guide after its launch and how can they get further information on how to use it?
Faith: The guide will be posted on the NAPF website (here), as well on the PRI clearinghouse. Leanne, Daniel and I are all available should anyone need any further information on how to use the guide in practical terms. There will be more details on our outreach program in the coming weeks and months.
(2) Supportive asset owners include (as of launch): BTPS, PPF, Kingfisher, West Midlands, Strathclyde, SAUL, Environment Agency, Merseyside, NILGOSC, Pensions Trust, Lothian, USS, Unilever, BBC, NEST, RPMI Railpen