As socially responsible investing continues an inexorable march toward the investment mainstream, some institutions are questioning the consistency or uniformity of environmental, social and governance (ESG) analysis, and how this analysis is adopted across investment managers. Some are questioning more deeply, also, the degree to which asset management firms meet certain ESG criteria for themselves as business entities, according to market practitioners. Others note that the nature of the ESG concept precludes uniform analysis and application.
“Data we are seeing is indicating a growing interest among asset owners in the U.S. in assessing how asset managers are thinking about ESG criteria in their evaluation of investing in various securities,” according to Tim Barron, chief investment officer at investment consultancy Segal Marco Advisors. “Compared to Europe, however, this is still much less than the majority of asset owners. One of the reasons for this is the lack of clear direction and uniformity regarding exactly what to consider. While the PRI does provide substantial guidance regarding criteria, asset owners, working in many cases with their consultants, appear to be developing their processes independently,” he said. The Principles for Responsible Investment (PRI) are a global set of standards for responsible investing as it relates to ESG.
Unlike financial metrics, ESG metrics are not uniform across managers. But Barron said there are signs now that asset owners may be starting to question this, at least in certain ESG areas. “We do see a rising interest in understanding how asset managers address several important “S”[social] characteristics, especially in the areas of diversity, pay parity and practices directed towards creating a favorable (not hostile) work environment. A number of asset managers will directly address all three factors in their presentations and meetings, pointing to environmental factors such as green offices, double-sided printing, smaller pitch books, and moving towards paperless environments. But the “E” [environmental] seems less of a focus at this point, however. Naturally, the “G” [governance] has long been viewed as an integral part of manager due diligence because good governance is equated with important characteristics of a well-run company that enhances stability and helps to retain the best people.”
A recent Morgan Stanley Investment Management report, titled Sustainable Signals: Asset Owners Embrace Sustainability, found that of 118 large public and corporate pensions, endowments, foundations, sovereign wealth entities and insurance companies polled worldwide, 70% have already implemented ESG strategies and 84% are pursuing or actively considering ESG integration in their investment process.
Asset owners in the survey cite risk management and potential for returns as top drivers of interest in sustainable investing. But, despite their recognition of these opportunities, they highlight the need for better data and investment information as a challenge to greater uptake of the style.
“There is still a gap between interest and implementation—with investors citing access to quality ESG data as a top concern,” stated Hilary Irby, co-head of global sustainable finance at Morgan Stanley, in a release accompanying the report.
I get frustrated hearing about ESG integration as if it were a standardized thing. There are different ways firms integrate ESG—it varies. It’s very broad, it’s inconsistent, it’s rich, it’s full of good information, but it’s also full of noise
Questioning the uniformity of ESG analysis
Currently, there are no standardized rules for ESG disclosures, nor is there a disclosure auditing process to verify reported data. Earlier this month, the American Council for Capital Formulation (ACCF) questioned the ratings process used for ESG investments. In a report titled Ratings that Don’t Rate, ACCF noted that, “As the trend of Environmental, Social, and Governance investing has risen, so too has the influence and relative importance of ESG rating agencies.” It continues: “Individual agencies’ ESG ratings can vary dramatically…Individual companies can carry vastly divergent ratings from different agencies simultaneously, due to differences in methodology, subjective interpretation, or an individual agency’s agenda.”
Jon Lukomnik, managing partner at Sinclair Capital, a New York City-based boutique consultancy involved in corporate governance and institutional investment, said that more than 100 ESG risk rating agencies exist. “They offer different things. People are trying to accomplish different things with different goals in their ESG analysis. So why would one say the analysis is inconsistent? That’s naïve,” he asserted. He explained that the purpose of asset management is to one, give investors optimum investment risk-return, and two, to intermediate the efficient allocation of capital for economic and societal good. “So you have these two functions. And one issue is that ESG analysis tries to encompass everything along that spectrum,” he said. “One could look at ESG and be solely concerned about the risk/return side at one extreme. On the other extreme, one could say ‘I just don’t want to own ‘carbon intensive’ stocks. I don’t care about risk-return.’”
Similarly, Eileen Neill, a managing director and senior consultant with Verus, believes “we should not expect consistency or uniformity of ESG adoption and implementation by investment managers because they need to adopt an approach that is coherent given their respective investment processes and strategies. Additionally, managers are also incorporating client preferences and demands into the equation in determining the extent to which they integrate ESG into their respective investment processes and strategies. Thus, one should not expect ‘consistency’ or ‘uniformity’ of ESG adoption among investment managers. Those would be, frankly, undesirable outcomes.”
“I think we are still in the early innings here,” Lukomnik said. “I’ve spent 30 years in the field and I think it is unfair to expect some kind of standardization. I get frustrated hearing about ESG integration as if it were a standardized thing. There are different ways firms integrate ESG—it varies. It’s very broad, it’s inconsistent, it’s rich, it’s full of good information, but it’s also full of noise,” he said. In the future he anticipates more consistent corporate disclosure regarding ESG—much like current financial disclosure regimes—but, he noted, “If you give the same financial disclosure to six banks you’ll get six different interpretations.”
Are asset managers practicing what they preach?
Neill said she thinks some investors are assessing ESG integration not only at the strategy or investment process level, but also at the firm level. “These concepts are not fully parallel, but some large U.S. public funds are looking at both aspects when evaluating investment managers.
The most prevalent trait under scrutiny is the investment firm’s diversity and the degree to which diversity is reflected within the organization’s ranks,” she said.
“The question is, are investment managers holding themselves to the same standards—including ESG factors—that they are using to evaluate companies as potential investments?” stated the chief investment officer of a large Mountain States public fund. “It seems that many people are asking external managers if they use ESG factors in their process for selecting individual companies, but beyond asking this question, it is unclear to me how plans that are allocating capital to external managers have integrated the ESG factors as part of their evaluation of the external manager’s organization,” he said.