Asset managers are increasingly claiming environmental, social and governance (ESG) credentials when marketing funds, but there are no standardised benchmarks and there is a scarcity of data with which to measure performance.
A recent report by Longitude Research and State Street Global Advisors (SSGA) found that over half of asset managers have difficulty benchmarking their ESG performance against peers, and over half also said they struggle to evaluate other managers and external research firms.
The May 2017 Performing for the Future survey found that the more deeply ingrained the ESG strategy, the greater the difficulty; it seems that as understanding about the subject grows ESG considerations proliferate.
Research and benchmarks tends to focus on one aspect only, such as Trucost research on climate risk. Therefore, managers are left having to use a variety of methods to assess impacts that range from company culture and engagement policies to third-party relationships.
For consumers, ESG labels are even more opaque. Last year Morningstar started rating funds for their sustainability, using as its basis company-level ESG data from Sustainalytics on the funds’ holdings.
The results caused some consternation, as almost half of the so-called socially responsible funds came out as rated average or worse than conventional funds, including funds run by JP Morgan Asset Management, Aberdeen, Robeco, Pictet and UBS.
In fact, five of the 193 funds examined were rated low and 30 were categorised below average. Some 13 of Robeco’s socially responsible funds scored below average, prompting the Dutch asset manager to point out the research did not take into account its active engagement with company managements.
“Most funds in this field measure up well using our sustainability rating, which is a holdings-based indicator of how well companies in a fund’s portfolio perform on a number of sustainability measures,” says Jon Hale, director, sustainability research, at Morningstar.
“Most receive the highest two ratings. Those that do not may be ethical funds by virtue of having certain exclusions but probably do not incorporate sustainability – or ESG – analysis into their process.”
He adds that any ESG fund ought to be awarded four or five globes under the Morningstar system but that there may be “a defensible reason if a fund doesn’t rate highly,” such as being in a competitive category where many funds score well or “some element of its investment process may not be captured in our rating”.
This goes to the heart of the problem: there are too many aspects to capture and a wide variety of approaches are used, far more than a simple shift from negative screening towards active shareholder engagement.
“Just because a fund uses some values-based screens doesn’t mean it is using ESG analysis at all,” explains Hale.
“It’s values-based insofar as it’s about wanting companies to be good stewards of the environment, great places to work, make safe and useful products and govern themselves with integrity and a long-term view.
“A fund can approach this in a number of ways. It can focus its investment universe on companies that perform better on ESG, and then move on to stock selection.
“It can make sure its analysts are integrating ESG factors in their routine analysis of companies and sectors. It can focus on a few key E or S or G issues that it thinks are especially material. Or, it can focus on broad themes – such as women in leadership.”
Asset managers incorporating ESG into their investment process need to describe how they do so in their prospectus documents.
Even then, however, the initial stock selection is only part of the story. Solid performance requires a buy-and-hold mentality, but this is at odds with the way the industry works.
This helps explains why ESG has not been widely adopted by pension funds even though pensions have such long time horizons, according to Richard Butcher, managing director of pension and actuarial consultancy PTL.
“Every report produced for a board of trustees starts with three-month performance. The consultants and asset managers are both judged over a short timeframe, and there are parties in the investment chain that need to trade to make their money.
“Inevitably, in such a competitive industry, there are also many who pay ESG lip-service. Many funds are making bold assertions but not living up to them, often piggy-backing off someone else’s research. Intellectually, it’s a real snake pit.”
The United Nations-sponsored Principles for Responsible Investment (PRI) organisation has made progress in setting industry standards, increasing accountability and educating investors.
However, there is still much work to be done on filling skill gaps in ESG analysis and concerns about the costs of developing the necessary systems.
PRI has more than 1,600 signatories managing $62trn in assets, and has sometimes threatened to expose asset managers who are not toeing the line.
In May, for instance, a handful of asset managers – BlackRock, Invesco, BNY Mellon and Vanguard – voted against climate change resolutions at the AGMs of the oil majors ExxonMobil and Chevron.
There is an irony here. For example BlackRock, alongside SSGA, has made the loudest stand this year to persuade investors that it sees climate change as a top priority, and has been heavily promoting the reporting framework developed by the Financial Stability Board’s Task Force on Climate-Related Financial Disclosures.
Different parts of these behemoths clearly have very different priorities.