ESG has become mainstream, and its popularity is only going to grow. Although techniques for assessing asset managers’ ESG performance are becoming increasingly sophisticated, there is no commonly agreed method of applying them.
As this was the most well-selected session, it was run with two groups. The findings from both groups has been combined.
The state of play:
- ESG has become mainstream, and its popularity is only going to grow.
- Techniques for assessing asset managers’ ESG performance are becoming increasingly sophisticated, but there is no commonly agreed method of applying them.
- Indeed, there are more than 100 ESG data providers, and approaches to the methodologies behind ESG ratings vary significantly.
- While standardisation comes with challenges, it is deemed important for both investors and investment managers to allow investors to accurately compare funds’ ESG performance and mitigate ‘greenwashing’.
- When it comes to standardisation and the measuring ESG performance, the first issue to address is the raw input: where the ‘information chain’ begins. Traditionally, this has come from companies disclosing to the market themselves, and there has been a successful effort in recent years to increase corporate disclosure. However, third-party frameworks which aim to precisely codify ESG principles have become increasingly sophisticated and prominent.
- The second issue to understand is, of course, the output. It is well-documented that ESG ‘scores’ from different rating providers’ systems correlate little with one another and aren’t subject to regulatory oversight, unlike credit ratings agencies, for example. This lack of clarity has deterred and confused investors. What is needed are consistent, more scientific approaches to managing raw information that make use of innovations such as ‘big data’ and artificial intelligence to assess companies’ supply chains, treatment of customers and more.
- This lack of clarity is as important to investment managers as to investors. It is felt by some that by implementing a standardised framework, the relationship between ESG and the investment manager’s fiduciary duty becomes clearer.
- It was noted, however, that there is a danger in applying rigid metrics. BP, for example, could be considered both a problematic and ESG-friendly stock: some argue that it should score poorly due to its carbon footprint; others argue that BP is one of the companies leading the drive towards renewable energy sources. It is important that nuance is not lost, and that investment institutions remain able to take differentiated approaches to ESG performance analysis.
Setting the standard:
- Going back 15-20 years, there were not many standard-setters, let alone clear ‘winners’. Recently, however, some have come to the fore, notably The Taskforce on Climate-related Financial Disclosures (TCFD) and the Sustainability Accounting Standards Board (SASB), which are increasingly recognised as leaders in setting the standards for corporate disclosure and investment analysis.
- SASB’s framework outlines a ‘taxonomy’ of 26 different themes from which companies can choose the most relevant to their business and define the key areas on which to disclose. Crucially, SASB has gone further than peers by bringing in the concept of ‘financial materiality’, which identifies, by industry, which of the 26 categories are genuinely financially material for that company. This is particularly helpful for organisations of limited resources, who can use this to identify what matters most to investors in their types of businesses.
- The subject of greenwashing was important to delegates, who noted that some of the larger asset managers had been accused of this. This issue is critical from a reputation management view, not just for individual firms but for the asset management industry more broadly. Developments such as the EU’s taxonomy for sustainable finance - which is introducing ‘labelling’ standards for green bonds; low carbon ETFs; and other explicitly ESG-branded products are therefore welcome.
The need to differentiate:
- The key consideration for asset managers is how they differentiate themselves from their peers in what is an increasingly crowded market.
The momentum is with ESG:
- It’s undeniable the momentum is with ESG, but where does this momentum go? Whilst some will continue to view the extremely low correlation among traditional providers of ESG metrics as problematic, as it does not provide a consensus around individual companies’ ESG performance; others recognise that there is an opportunity for differentiation by exploiting these differences in the ESG landscape and taking proprietary approaches to analysis which leverage a range of data inputs, for enhanced investment decision-making.
- Delegates were interested to discuss how firms will differentiate themselves as ESG continues to grow, and whether ESG ratings providers should be regulated. ESG may cease to exist as a label, instead becoming so tightly integrated into the asset management industry that it becomes akin to food standards: funds are vetted for adherence to a basic set of ESG principles. Differentiation would therefore occur after, with asset managers scrapping ‘ESG funds’ in favour of fully ESG integrated funds, or thematic funds dedicated to specific issues, such as carbon reduction or water quality.
The need to rally around a specific benchmark comparison:
- One practice we have seen from clients is ‘multi-vendor’ sourcing, by which a number of providers’ methods are synthesised to build a composite model. If this grows, however, we could theoretically arrive at a situation in which every single asset manager applies a different methodology.
- A solid understanding of what constitutes good performance is, of course, critical to this debate. As well as the performance of holding companies, the ESG credentials of investment managers themselves are increasingly scrutinised, with some managers seeking to prove that they have been strong in this area before it was popular. There is, however, no benchmark to do so and delegates agreed that the industry needed to rally around some sort of benchmark comparison.
What is happening in other countries?
- An area of interest to delegates was the differences among countries. In some European countries, notably France, ESG is seen as a form of accreditation which, once achieved, requires little further discussion. It is, in this sense, akin to a regulatory obligation – or a ‘ticked box’. In the UK, however, the conversation is much more fluid and analysis is deeper; funds’ credentials are interrogated more. In the US, the conversations between asset owners and asset managers on ESG are much more primitive, with such products treated with much more scepticism – this contrasts with Europe where there is a ‘race’ to lead this market.
Clients want different things:
- A challenge that comes in such a burgeoning market, though, is that clients all want something different. Some are arguing for divesting from oil companies, for example, while others are encouraging asset managers to engage and affect change. It was agreed that, in the experience of delegates, engagement does work, although it requires a coordinated and long-term effort on the part of investors.
Do ESG strategies outperform the market?
- Delegates also debated whether there was any evidence that ESG strategies outperformed the market. There is no doubt that some strategies have but the picture is not yet clear. Related to this, delegates questioned whether enthusiasm for such products would endure during a bear market or an economic downturn, as this would really test investors’ true appetite.
- There is great work being done in the standardising and refining of ESG metrics, but this needs to continue. There is currently no perfect system, and we won’t see a ‘silver bullet’ in the near future.
- To refine credible, standardised metrics, it is imperative that asset managers talk to clients to understand what they want.
- Ideally, these should be digestible and easily understood by clients: perhaps a handful or so categories – such as diversity and impact investing - which clients can pick and choose to model products around.
- In the meantime, we should accept that the market is currently imperfect but work towards constant improvement.