Update offers investors a greater range of supportive tools, materials and data sources for integrating ESG considerations, emphasises key role for stewardship.
The Principles for Responsible Investment (PRI) has updated its guidance on integrating ESG factors into equity investing to better incorporate stewardship considerations, reflecting also growing sophistication among practitioners over the past seven years.
The UN-supported investor network said the framework had “consistently been” one of its most popular technical guides since its launch in 2016, but that the world had “moved on”, in terms of standards, tools and data, with the new guide aiming to “capture and share the latest leading practice”.
The new version of the Practical Guide to ESG Integration for Equity Investing identified client demand, regulation, sustainability outcomes, and materiality as the principal drivers of increasing integration of ESG factors into listed equity analysis and investment among its signatories. It also noted investors’ greater willingness to “wield their voting power and collaborate in holding companies to account”.
Mickal Bartek, Listed Equity Lead at the PRI and the guide’s lead author, said it “ultimately tries to do one thing” in explaining how E, S and G considerations can be incorporated in the three core listed equity strategies – active fundamental, active quantitative (quant) and passive investments.
The updated guide, which “supersedes and replaces” the 2016 version, includes stewardship in a “much more integrated way”, he added, further recognising the way investors can incorporate ESG factors.
The guide said that stewardship activities are “not easily separable” from the investment process, due to stewardship being informed by, and feeding back into, insights gained during the investment process, with the guide exploring how to implement stewardship activities.
Increased stewardship integration
Stewardship is one of the five modules covered in the update – alongside responsible investment policy and beliefs, governance, investment process, and monitoring and reporting – which form part of the ‘investment cycle’ into which ESG factors must be integrated to “better manage risks and improve returns”. It also features prominently in the investment process module.
The new guide highlighted that participation in collaborative stewardship initiatives increased from 68% in 2017 to 83% in 2020, with asset owners “particularly driving the change”. It also recommended that asset managers and asset owners should develop and disclose a stewardship policy consistent with local regulation, stewardship codes and the six Principles for Responsible Investment.
“Sometimes stewardship is seen as a bit of an ‘add on’ to the investment analysis and portfolio construction,” said Bartek. “In this guide, we are trying to show that there are close links between stewardship activities and the analysis, forecasting, valuation and portfolio construction. They’re much more intertwined.”
For active fundamental strategies, the guide identifies the analysis stage as “key for investor stewardship”, with investors being able to identify potential operational improvements that can be pursued through engagement with company management.
The guide identifies passive strategies can utilise investor stewardship activities in the context of long-term relationships with issuers address market-wide systemic issues. It says passive investors may consider different levers to achieve their stewardship objectives, such as engaging policymakers should differences in strategy arise with investee firms.
“The investment process and stewardship are not two distinct separate kind of consecutive activities. This guide helps identify where those connections are,” Bartek added.
“Greater depth of everything”
There was “no single trigger” for the guide’s update, said Bartek, adding that it was instead driven by a “significant improvement in the knowledge and awareness of material factors” around ESG integration since its initial launch seven years ago.
“There is a lot more data out there, a lot more offered by service providers, a greater range of metrics and more established and standardised ways of describing the factors and measuring them and reporting on them,” he added.
“Many more investors these days pay attention, or at least claim to be paying attention, to ESG factors,” Bartek said. “Whichever aspect of investing you look at, there is more ESG out there in relation to pretty much all the key investment strategies and a much greater range of funds.”
The upgrades to the guide centre on offering investors a greater range of supportive tools, materials, and sources of data, in addition to greater integration of stewardship. The guide now goes into greater detail in relation to “every single one of those three core approaches”, according to Bartek.
Some ESG quant strategies can be tested in a “much more accessible way” due to the increased amount of data and longer track record of it, he noted, while the evolution of passive strategies has seen investors “designing custom indices in a way that wasn’t really possible several years ago”.
“There’s basically more of everything and a greater depth of everything,” Bartek said.
Continuing to evolve
According to Bartek, the guide will be used by a “range of entities”, including signatories that have only recently joined the PRI. As of the firm’s most recent signatory update from Q4 2022, the PRI had 5,319 signatories, representing US$121 trillion in AuM, with 140 global organisations including 14 asset owners becoming PRI signatories during the quarter.
“They are looking for some official guidance on what steps to take where to get hold of data, what frameworks are out there available for assessing materiality, or in what way one can make adjustments to valuation models,” Bartek said. “All that is covered in this guide, and hence those who are not particularly experienced can learn a great deal from this.”
A former fund manager, Bartek said best practice among investors had developed significantly over the past decade from a somewhat subjective and inconsistent approach a decade ago.
“From that space, we’ve seen a huge evolution in both knowledge and the realisation of increasing materiality of the ESG factors,” he added. “Going forward, we need the general knowledge and pressure from beneficiaries, regulators and the wider society to continue to grow because ultimately those are the drivers of why these factors have been taken into greater consideration.”