Industry

ESG Not Sufficiently Factored into Manager Selection

PRI data flags asset owners’ lack of concrete requirements for asset managers to support responsible investment strategies.

Asset owners are not yet fully incorporating ESG factors into the selection and monitoring of asset managers through formalised processes and detailed assessments.

A new report by the Principles for Responsible investment (PRI), the UN-backed body for asset owners and managers with a focus on responsible investment, says it is common for asset owners to consider prospective asset managers’ responsible investment credentials.

But CEO David Atkins noted that asset owners should take further steps, stating that “a significant portion of asset owners are yet to incorporate ESG into formal contractual arrangements with asset managers”.

According to the report, 87% of asset owners said they consider prospective managers’ investment approach, objectives and philosophy against their own responsible investment criteria when awarding active listed equity mandates, while 85% said they do the same for active fixed income. But only around three-quarters of asset owners said they assessed asset managers’ governance structure, management and oversight.

Further, nearly a third of asset owners (30%) do not contractually require managers to follow their responsible investment strategy for all or the majority of the fund’s assets under management.

“Few look beyond standard responsible investment reports when assessing and monitoring asset managers,” said Atkins.

Requirements that managers adhere to specific practices as a condition for selection are less than consistent, the report found. The most common requirement is that managers incorporate material ESG factors into all investment decisions and analyses. As many as 72% of asset owners make this requirement for actively managed listed equity assets, but only 55% do for passively managed listed assets.

There is also variation across asset classes, with 61% of asset owners requiring that managers of their actively managed fixed income assets comply with their exclusions policy, but only 51% requiring it for their passively managed fixed income investments.

The report is based on data from nearly 700 asset owners signed up to the PRI, a number growing by roughly 15% each year, with 57% based in Europe and 21% in North America. A total of 49% of signatories have over US$10 billion in assets under management, with retirement plans making up over half of the total organisations in the report, followed by insurance funds as the next largest group at 17%.

Barriers to integration

Toby Belsom, the PRI’s Director of Investment Practices, said there are “a number of barriers” preventing asset owners from formalising ESG incorporation into manager selection processes and investment mandates.

Belsom suggested that there remained some caution among asset managers over the extent to which they should formalise ESG integration due to confusion over legal advice over fiduciary duty. He also highlighted practical challenges around the ability of asset owners to introduce ESG factors into pooled or co-mingled funds, as well as uncertainty over benchmark selection.

“One of the issues around a specific investment strategy in ESG passive indices is the complexity of how these are constructed, which subsequently makes it difficult to really understand what those indices provide as well as the decisions needed to select these products,” he said.

Issues relating to fiduciary duty were addressed in a recent PRI report which explores and clarifies the scope of an asset owners’ responsibilities. It concluded that approaches where “investors intentionally seek to influence what investee enterprises and third parties do in assessable ways that address sustainability challenges” are permitted by law to a significant extent, while noting variations across jurisdictions and investor types covered.

The PRI has also provided guidance in recent reports on embedding ESG factors and sustainability outcomes into investment mandates.

The monitoring of asset managers by owners was also seen as an area for increased attention to achieve maximum ESG impact. The latest PRI report said monitoring managers’ alignment with the asset owners’ responsible investment strategy is significantly more commonplace than monitoring how ESG incorporation affected financial and ESG performance.

Across major asset classes, fewer than 60% of asset owners are monitoring all or a majority of assets, with monitoring responses to material ESG incidents higher at 82% in infrastructure and 78% in real estate than in other asset classes. Monitoring of stewardship practices also tends to focus on “high-level” activities and actions, the PRI found.

But more than 80% of asset owners have some form of escalation process to address concerns by the monitoring. The most common approaches including telling the manager they have been placed on a watchlist and terminating the contract if their failings persist.

Belsom acknowledged that smaller asset owners continued to face resourcing challenges in exercising oversight of managers. “One theme throughout the report is that asset owners with a smaller amount of assets under management undertake fewer processes more broadly. They would probably also have smaller pools of capital that have reduced leverage on the asset manager to undertake stewardship practices or implement responsible investment policies,” he said.

 

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