The plight of the small, resource-constrained asset owner when it comes to responsible investment

With the recent Pension Regulator (TPR) guidance on environmental, social and governance issues, asset owners will be under even greater pressure to adopt meaningful responsible investment policies. To better appreciate the future challenges of this new landscape, let us imagine a scenario whereby there is a small, resource constrained asset owner, 100% externally managed, with no internal responsible investment resource or expertise. Indeed it is not crazy to imagine this scenario, as it likely represents a significant proportion of asset owners in the UK.

On the back of this regulatory pressure, this asset owner is now tasked with re-exploring their investment beliefs and strategy as they pertain to the consideration of environmental, social and governance (ESG) issues within their investment process. After some assistance from their investment advisor, they manage to revise their Statement of Investment Principles, craft a revised set of responsible investment beliefs, fund manager expectations on ESG, stewardship policies and so on and so forth.

For new mandates, this represents a clean slate. Everyone is going into the contractual relationship with clear expectations and contracts can be constructed accordingly on the back of them. In fact, it is amazing how agreeable the fund manager may be to adhere to these new policies. However, new mandates do not come along every day. In reality, for the most part, the asset owner has to reach out to its existing managers with its new in-house policies.

Let’s use as an example a voting policy such as Red Line Voting. Immediately problems arise…

– “When you hired us, you endorsed our entire investment process, including our voting policy”

– “We do not have the resources to do this, this will be an extra cost”

– “We do not agree with certain elements of your policy”

And so on and so forth…

One could easily use the “customer is always right” or “these are our assets, not yours” arguments at this point in the piece which in my view are fully justified. But given the complexities involved in this problem, we will explore other angles here which are equally, if not more, important than the above noted principles, if we are seeking a step change here.

So now, the asset owner is left with an in-house voting policy that cannot be implemented. It does not believe that removing the assets from the fund manager is the most constructive way forward. So what to do? The asset owner decides to go back to the fund manager to offer a compromise. It asks for the fund manager to report the voting activities on the portfolio in question on a quarterly or six monthly basis, noting any deviations from its own in-house voting policy and a justification for the deviation. More roadblocks ensue…- “We cannot do this, because we would need to offer this service to all our clients, which would result in too great a cost”

– “We do not have the infrastructure or resources to facilitate this request”

– “We can attempt to create this report, but it will be a lot of information, will you actually read it?”

The asset owner is confused. This feedback does not occur for – dare I say – the “mainstream” quarterly reports that they receive. Why are ESG considerations held to a different set of standards than any other set of financial risks/opportunities? Why do fund managers not have the necessary resources or infrastructure to adhere to clients’ needs in this area?

The moral of this story is simple: asset owners get charged with not sending a strong enough signal to the fund managers on their ESG expectations. But when attempts are made by quite a small minority, problems like this case study arise. And if these problems continue in light of this new regulatory environment, the asset owner will be left with responsible investment policies driven by what the TPR has asked of them, but with an inability to implement them. This represents an impasse that needs to be addressed. Yes, it is true that trustees can replace uncooperative managers, but that process consumes resources of scheme money and trustee effort, such that these issues should normally happen in the context of a more general investment review.

As Professor Kay pointed out, it is clear that greater accountability mechanisms, and indeed trust, need to exist between asset owners and fund managers. Asset owners are not just stakeholders to be managed or even worse patronized when it comes to RI. They should be considered as partners to help them shape their own RI approach to be more in alignment with their needs. Developing this partnership is even more important in light of an ever changing market and regulatory landscape, including a Millennial generation who will no doubt have a stronger beneficiary voice in the near future.

This is admittedly a complicated issue that cannot be resolved overnight. But one thing is clear: at a minimum and at this stage, fund managers should be prepared to better defend – at a mandate level – the policies they do have through improved reporting, against client policies. It was indeed this very issue that prompted sixteen UK pension funds to create the Guide to Responsible Investment Reporting in Public Equity in 2015. If asset managers are not even prepared to do provide mandate specific ESG reporting to clients and most importantly justify their RI approach, it puts the legitimacy of the responsible investment agenda into question.

Leanne Clements is Red Line Voting Campaign Manager at the Association of Member Nominated Trustees (AMNT).