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October 18, 2021updated 21 Feb 2022 1:18pm

ESG integration: Easy to say but very hard to do

Investors increasingly claim to be incorporating ESG factors into their portfolios. But are they doing so genuinely and for the right reasons, and what should best practice entail in ESG integration? The concept is still vague, with a clear definition some way off.

By Vibeka Mair

ESG integration

Masja Zandbergen of Robeco believes pressure from asset owners is pushing more managers to take ESG integration seriously.
(Photo courtesy of Robeco)

  • ESG integration is rising at a “staggering” rate among investors, finds a BNP Paribas survey, with brand protection cited as the main driver of this trend.
  • But some question what ESG investment best practice entails and whether it is genuinely being implementing across portfolios.
  • This reflects wider concerns, as a growing number of high-profile ESG executives warn the asset management industry is rife with greenwashing.

Just two years ago, not one investor in a sizeable sample said their organisation incorporated ESG factors into all of their investments. Fast-forward to May this year and 13% said the same, with a further 19% expecting to do so by 2023 (see chart below). Such were the findings from BNP Paribas’s global ESG survey of asset managers and asset owners, which this year polled 145 of the former and 211 of the latter.

The French bank’s latest report, released last month, indicates “a staggering upsurge in commitment” to ESG investing, say its authors. It describes ESG integration as the process of including ESG factors in investment analysis and decisions to better manage risks and improve returns.

On the face of it, this appears to be positive news – but dig a little deeper and a more nuanced picture emerges.

The main driver of ESG factor integration is a desire to avoid damage to brand and reputation, according to the new survey. This motivation was cited by 59% this year, up from 47% in 2019, overtaking "improved long-term returns", the top answer in 2019.

But the poll results took place just weeks after former BlackRock sustainable investment chief Tariq Fancy published his now-infamous opinion piece on ESG investing, fuelling a backlash against the concept and the potential it poses for greenwashing. This has triggered worries among asset managers about potential reputational damage around this issue.

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Such concerns are even more acute today in light of the investigation of fund house DWS by the US Securities and Exchange Commission and Germany’s Federal Financial Supervisory Authority following greenwashing allegations made by former DWS employee Desiree Fixler. DWS’s shares fell 13% when the greenwashing claims hit the press in August and have still not recovered any of their losses.

A mere marketing tool?

All this reflects what some see as certain key underlying issues with ESG integration: that it is seen more as a marketing tool than as a way of creating more resilient long-term investment portfolios and having a genuinely positive impact on society and the environment.

“Many asset managers are now [integrating an ESG focus into their investment strategies] because their clients are asking them to,” says Masja Zandbergen, head of ESG integration at Dutch asset manager Robeco. “Then the sense of purpose of why they’re doing it is not always there, when that is something that needs to be established as a first step to really start integrating ESG.”

Indeed, "external stakeholder requirement" was the reason cited most by asset managers when asked what drove ESG integration in their portfolios, according to the BNP Paribas survey. It was mentioned by 49% of them, just ahead of "brand and reputation" with 48%.

Robeco has been focused on sustainability for longer than most of its peers, having started integrating ESG into its approach in 2010. Zandbergen wrote the company’s ‘Seven Steps to ESG Integration’ paper, which lays out its investment philosophy.

A fundamental and first step, she tells Capital Monitor, is to underpin the investment belief with strong frameworks. “A lot of people active now in sustainable investment maybe haven’t even looked at what are the basic principles for human rights or what is the Rio Declaration on Environmental and Development,” Zandbergen says. “What are the key basic principles there? And that is really the fundamental basis for starting”.

Moreover, with true ESG integration, ESG factors are treated on a level playing field with other information in financial analysis, says Rick Lacaille, who leads ESG initiatives across asset management at servicing group State Street.

Similarly, an ESG framework should be applied across an entire portfolio, say industry participants, but that is a lot easier for some asset classes than others. Data on listed equities is easier to come by because of corporate reporting obligations than on, for instance, sovereign debt or private market assets such as real estate.

In the BNP Paribas survey, listed equities was reported as the primary asset class to which ESG is applied, with 69% of asset managers and owners citing it. The figure dropped to 45% for fixed income and 37% for real estate.

Maria Nazarova-Doyle, head of pension investments and responsible investment at British life insurance and pensions provider Scottish Widows, underlines this point.

Scottish Widows Pension Fund has committed to integrating ESG across all of its investments, she says, but for some asset classes it “hasn’t figured it out yet”.

“Government bonds – that’s such a tricky area,” says Nazarova-Doyle. “We’re making good progress in equities and we’re starting to look into corporate bonds.”

No agreed standard 

Part of the problem – as so often with sustainable investing – is that there is no agreed standard for best practice on ESG integration. In the absence of any such benchmark, Scottish Widows, for example,  takes a bottom-up approach to researching fund managers, Nazarova-Doyle says. This includes sitting down with them to understand their ESG processes and policies and get examples of how they are implemented.

Data gathering is key to ensuring managers can be assessed properly. Scottish Widows is working with its main asset managers to create better reports on, say, carbon levels or diversity measures, Nazarova-Doyle says. “If we see those stats worsening, we can legitimately question the managers [on why that is the case]. So it’s very important to measure and to monitor to be able to do that. But it is really hard.”

It is tricky to integrate ESG into government bond investing. Maria Nazarova-Doyle, Scottish Widows

The fact is that definitions and methodologies around concepts such as ESG, impact and sustainability have been vague, allowing – or forcing, depending on your point of view – investors to infer their own expectations or interpretations.

It is a difficult problem to resolve, though some regulators are trying.

The EU is seeking to address the issue with its Sustainable Finance Disclosure Regulation (SFDR) – which categorises funds as Article 6, 8 or 9 according to their level of ‘greenness’ – and taxonomy for sustainable finance.

Since SFDR does set some standard for ESG, it drives investors to be more transparent and to think harder about what they call sustainable assets, says Zandbergen. “And also to have the discussion not only on the financial side, but also on the impact side.”

Petra Stassen, senior responsible investing specialist at Dutch fund house NN Investment Partners, which in 2019 developed a systematic approach to ESG integration, makes a similar point.

The process of complying with SFDR helps asset managers think about their investment approach, she says. “Writing it down in a standardised way… also triggers additional questions, which I think will help the industry in the end.”

Concerns over SFDR

There are those, however, who argue that SFDR in fact raises its own risks of greenwashing by allowing asset managers to claim erroneously they are offering ‘green’ funds. After all, most of the products classified as ‘light green’ under the SFDR contain fossil fuel investments, as Capital Monitor reported in late June. A key problem is that full technical guidance on the regulations is lacking and is still yet to be provided.

Meanwhile, some think it is very difficult to categorise investments as ESG in this way. Lacaille is “sympathetic with the aim” of making it clear to customers what they are buying, but he warns that it is “a little bit of a perilous journey” as ESG is “elastic”.

“That’s the challenge with the [EU] taxonomy and SFDR… you’ve got all these anomalies when you are trying to get more grounded and precise,” he adds. “It’s a really worthy goal, but it’s a very tough thing to do.”

Bård Bringedal, chief investment officer for equities at Norwegian asset manager Storebrand, takes a similar view. While SFDR will be good for transparency, he says, sustainability isn’t “one-dimensional or static. You can’t put one reference point or one number on it.”

Ultimately, achieving a baseline standard for ESG integration “is still the million-dollar question”, as Bringedal concludes, but that remains some way off.

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