As a fiduciary, it is the role of the asset manager to ensure they manage money with the client’s best interest at heart. This is neither a new concept nor a controversial one. It is, however, increasingly important to understand the role a fiduciary can play within the context of sustainability as a component of the investment process.
Responsible investment has accelerated in recent years. Asset owner policy commitments, such as setting carbon emission reduction targets, strengthening exclusion policies, or ensuring greater inclusion and social equality, are being made at breakneck speeds. Keen to align with global political ambitions, such as the Paris Agreement, there is an appetite from asset owners to set clear ESG-linked targets; the hard part is making sure these goals are met.
And that’s where setting a responsible investment framework is vital. As the stewards of citizens’ money, institutional asset owners such as pension funds must ensure their financial obligations are not compromised while at the same time demonstrating they are supporting transformational processes to achieve real-world impact.
“My advice to institutional clients who are on their [net zero] paths, is to do it step by step,” explains Dennis Hӓnsel, who heads ESG advisory at DWS. “Don’t make a huge leap, an ambition to do everything in one go, start with the most important goals, like reducing greenhouse gas emissions, for example.”
In defining an individual framework for ESG integration, a fiduciary, such as an asset manager, is well placed to serve an asset owner with the advice, services and products most aligned with their individual targets. Deep knowledge is required to define frameworks, taking a net-zero strategy as an example, it is essential to consider the current regulatory environment, respective requirements, and impact that such a strategy should entail, in addition to an examination of what data is relevant and which form of ESG integration is necessary to reach individual goals.
“Working with a partner that can set out a holistic roadmap based on market standards, which supports customer-specific and regulatory requirements is important,” says Hӓnsel. “There are many factors that play into ensuring a portfolio is on track to reach certain ESG requirements and it’s vital that the potential impact of ESG integration on portfolios and the investment universe is understood before making specific investment decisions.”
Prime yourself for an ESG investment policy
The first step in implementing ESG is the definition of a general ESG strategy, which also includes investment beliefs, risk tolerance and return targets. This is then followed by the development of an ESG policy that specifies which areas (standards, climate, decarbonisation, for example) should be defined and the relevant threshold tolerance.
By doing so, institutional investors can ensure that their ESG policy aligns with the organisation’s culture, values and strategic investment approach. This alignment is essential for establishing ways to measure accountability. Moreover, the policy should have ownership at the highest level within the organisation and garner organisational governance buy-in to ensure its effectiveness.
Institutional investors should also familiarise themselves with regional and international ESG-specific legislation and ESG-related standards, as well as the recent ESG and responsible investment debates and key academic literature. Various resources, such as local sustainable investment forums (SIFs; for example, Eurosif), the PRI, the CFA and academic institutions, can provide valuable information and insights. Speaking to your asset management partners is also an important avenue for advice.
How ESG data can inform ESG decision-making
Another crucial element in implementing a successful responsible investment strategy is getting access to the relevant ESG data. This allows investors to assess and manage risks associated with environmental and social factors, such as climate risks, resource scarcity and labour practices.
By evaluating factors like energy efficiency and supply chain management, investee companies can identify opportunities for operational efficiencies, cost savings and innovation, leading to improved financial performance over time. In the same vein, by monitoring and improving their ESG performance, companies can enhance their reputation, attract more investors, and build brand loyalty. In turn, as the source of the ESG data, they are increasingly under the radar of portfolio investors, many of whom set investment parameters linked to those scores.
ESG data is typically compiled and organised with the help of data vendors. More and more investors have access to this data these days and are increasingly putting that data to a growing variety of uses, including ESG integration, implementation of negative exclusions and pursuit of an ESG best-in-class investment approach.
There are limitations
Reporting regimes, such as those put in place by the EU (think Sustainable Finance Disclosure Regulation, or SFDR) are new, and asset managers remain reliant on the level of data their portfolio companies are able to provide. Although the theory is sound, the practice is quite different – it is very difficult for individual companies to track the full extent of their carbon footprints, for example, as much as they may wish to.
There are tools available that allow asset managers to estimate and extrapolate carbon footprints, and, depending on the investment policy of an asset owner, these methods may prove suitable enough for the time being. Reporting will improve over time, but asset owners must be aware that they can be dealing with incomplete information.
Equally, with ESG scores, Hӓnsel advises a degree of caution. A simple score may prove indicative of a company’s ESG activity, but it is unlikely to be conclusive, as ESG is a subjective topic. Data vendors can have different methodologies to come up with their scores and these might not necessarily align with the ESG policies of a specific asset owner.
For example, an electric vehicle company may obtain a high ESG score with one data provider and a lower score with another. One might focus more on the environmental aspect, while another also considers social aspects or strong and transparent governance. “Understanding how scores are compiled is important as well as selecting the data that is the right fit for the investment strategy,” Hӓnsel reasons.
“Data vendors do good work, but the methodology may not be public. To mitigate that, we use a multi-vendor approach and look at a range of scores across the board. This approach increases reliability and coverage of ESG scores.”
An ESG score is simply just that – a score. If the impact is neither measured nor correctly understood, then the process is incomplete. For Hӓnsel, the impact might just be the hardest word in the ESG lexicon. It’s important to know if a company is making an operational change that will have a material real-world influence aligned with the asset owner’s objectives. Just saying you are investing more capital into a specific Sustainable Development Goal (SDG), is not necessarily proof of impact.
“Set up targets for your portfolios and, above certain thresholds, you can think about the impact or for example, that a certain company has a clear objective to achieve the highest possible sustainability share of investment,” says Hӓnsel. “Furthermore, data is important. There must be an observable and clear commitment that the company in question wants to increase their sustainability share through new investments. This provides you with the ability to monitor progress.”
Why asset managers can help
This is where working closely with an asset manager could prove beneficial. As shareholders themselves, and beholden to new reporting regulations such as the SFDR, asset managers are in a good position to support their clients in analysing ESG needs and translating them into targets, establishing suitable strategies and the set-up of respective policies, picking the right ‘raw data’ to create valuable investment signals and to advise on market standards, regulatory requirements and client-specific ESG considerations.
As fiduciaries, they are also there to guide and inform the asset owner of any shortfalls or risks inherent in the investment strategies they are pursuing. “We are here to tailor the products to the needs of the client,” says Hӓnsel.
“As responsible investment policies develop, so will our services in the form of funds and strategies that align with their ambitions. In some sense, there’s nothing new to this. Asset managers have been doing this for a long time. ESG and sustainability is, in that regard, an additional and complementary component to a fiduciary’s duty.”
Disclaimer: This editorial contribution has been prepared in partnership with a third party. Despite careful selection of sources, no liability is assumed for the correctness of the contents. All statements and performance data do not constitute financial analysis. They are for information purposes only and in no way encourage the purchase or sale of financial instruments or securities. Historical performance and any awards for it are not guarantees of current or future performance.