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November 2022
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ESG in the DNA

By Manoj R. Dani*   
  • Asia
  • Global
The UN’s Sustainability Development Goals are increasingly seen as the gold standard

Environmental, social and governance considerations and proprietary analyses have long been embedded within the investment philosophy of a number of asset managers. They have recognised how climate, social, health and economic events have accelerated the importance of integrating ESG criteria when evaluating and investing in equities, bonds and alternative assets. 

Some see their role as advocates for change and impact and look to build ESG integration in their approach to alpha generation. Others keep strategies focused simply on better risk management to protect the downside of any potential investment. 

The initial demand for sustainable investments was led primarily by a niche group of ethically-driven investors. This has developed into the mainstreaming of ESG considerations by pension funds, endowments and institutional investors. 

Amid the varied ESG stories amplified in the market, asset managers must prioritise how they communicate their unique approach with clearly defined and well-articulated goals. These goals must take into account their stakeholder audience. 

New Zealand-based Harbour Asset Management is a manager that has consistently rated highly for communicating and embedding ESG factors.

ESG has been part of Harbour’s overall investing philosophy right from the very beginning over 12 years ago. Two key aspects of that were developing its own proprietary ESG assessment survey to put companies through their paces, which was then integrated into the investment decision-making process, as well as engaging with reputable industry-leading initiatives such as the United Nations-supported Principles of Responsible Investing and the Carbon Disclosure Project.

A major challenge Harbour faced early on was the general lack of sustainability disclosure from companies, reflecting the importance of engaging and encouraging them to develop sustainability as a core value. 

When it came to communicating, the focus was on persistently raising awareness and pitching the value of ESG, given the then-prevailing perception that incorporating it into investments detracts or dilutes performance. This process took time and required unrelenting efforts to change mindsets, which is never easy. 

Measuring impact

Another approach taken by investment managers to introduce best practices and embed ESG into their investment processes is to partner with science-led non-government organisations that have robust internal governance. 

Some asset managers adopt scientific, quantifiable and verifiable ESG metrics and goals in their investment processes and portfolios and might, for example, collaborate with an NGO such as The Nature Conservancy, which may serve as conservation and science adviser or limited partner to an ESG impact fund. 

Arisaig Partners, a Singapore-based emerging-market equities manager founded in 1996, takes a research-heavy investment approach to enter investments with the aim to hold them “forever”. 

Arisaig believes companies which effectively address ESG issues are better able to drive innovation, lower operating costs, improve market access, enhance their reputation, and attract the best talent, thus supporting their ability to be sustainable for investors. 

Edinburgh-based manager Baillie Gifford acknowledges the difficulty of measuring impact, especially at a time when impact funds are not commonplace. 

Measurement of impact is still evolving and has room to improve, hence asset managers like Baillie Gifford consider the importance of Deep Transitions, the Global Impact Investing Network and the Impact Management Project to drive progress. The more accountable and credible impact investing can be, the more positive societal change can be generated.

The success of this awareness-raising has been borne out by growing widespread acceptance of ESG integration for many asset managers. It is now increasingly considered a necessity by most clients and asset consultants. The conversation has now moved to applying more sophisticated approaches and being true to label. Investors across the globe are on the lookout for greenwashing, as are regulators. 

Firms like Harbour, Arisaig and Baillie Gifford have taken a step beyond ESG and have launched their own impact investing funds designed to deliver dual outcomes, by making meaningful positive impacts measured against the UN’s Sustainable Development Goals (SDGs), as well as outperforming financially. 

The diverse range of investors now demanding ESG investment options beyond merely exclusions requires a diverse range of ESG investment products and communications strategies to suit their needs.

As market regulators introduce new guidelines, asset managers are coming to terms with the myriad evolving rules on reporting and disclosure. Even their investee companies have to adapt to the guidelines. 

As a Certified B Corporation – companies which are certified for their environmental and social performance – outdoor retailer Kathmandu Brands Group has aligned itself with the SDGs. MercadoLibre promotes financial inclusion in Latin America, while Taiwan’s global semiconductor giant TSMC has committed publicly to ESG goals and the SDGs with key metrics which it plans to track on an ongoing basis. The SDGs are increasingly seen as the gold standard for ESG and impact integration.

Communication is key 

Sustainability and ESG are thriving despite the turbulent geopolitical environment, market volatility, inflationary fears and their collective impact across world markets. Institutional investors, pension funds, endowments, foundations, family offices and private investors, are allocating capital to asset managers for ESG. 

However, ESG investing is neither well defined nor consistent. Until ESG ratings and audits are regulated uniformly, there exists the risk of fund washing or greenwashing – or at least the perception thereof. 

For the sake of their institutional prospects and clients, asset managers must design and implement a clear ESG communication strategy. These stakeholders are taking a greater interest in how asset managers address ESG issues. An asset management firm’s ownership structure, and the manner by which its investment committee members debate issues. can show evidence of the contribution of ESG analysis to outperformance. 

Once the firm defines what key metrics, ESG data and reporting solutions are important, it must choose which platforms to use to communicate the story. This is no easy task. While ESG data is more widely available, even in a market of consolidating providers, the results often contradict each other. It boils down to how well managers can align their strategy to how ESG assessments add value to their processes; they can then focus on tailoring client reporting to present this data. 

Stakeholders are increasingly pushing for better transparency, which would allow them to compare and contrast one asset manager’s ESG blueprints and investment offerings with another. 

There is growing demand for better communication and clarity as to how ESG supports an asset manager’s sustainable investment returns profile. At the heart of this is a clearly articulated ESG story to share with investors, prospects and internal stakeholders. 

The clarion call for better ESG disclosure comes alongside a sense of “ESG fatigue”, which some observers argue leaves institutions confused by conflicting vocabulary and varied taxonomy, and by the increasing number of asset managers who assert they have long integrated ESG in their respective investment processes. However, this temporary fatigue will not stop the direction of travel. 

Challenges 

Institutional investors and asset consultants need to differentiate among the wide variety of “green noise”, “climate thunder” and “proprietary” ESG methodologies of asset managers’ investment processes. 

Many asset managers often explain that they have a long history of engaging directly with company management on their capital structure, commercial strategies and any material ESG considerations. Most would claim they are corporate advocates who provide valuable feedback to inspire change and influence towards improving corporate practices, which in turn would (hopefully) manifest into higher ESG scores and ratings for their investee companies. 

In a crowded market, it becomes hard to have one’s voice heard and one’s ESG practices remembered. The challenge then is how to differentiate one asset manager from another. In essence, it boils down to consistency, authenticity and the clarity of messages presented. 

A typical fund manager might stake their claim to having adopted ESG for years. But this is often met with scepticism by most institutional investors. Decision makers and allocators simply wish to know what that means for them and their portfolios. Hence, regular engagement and dialogue with institutional investors are crucial. 

According to a KPMG report published two years ago, ESG investing is 85% driven by institutional investors, followed by 39% by institutional consultants. This means managers must invest time to understand how to frame ESG assessments and determine how to drive better long-term risk-adjusted outperformance and returns. There is always room to strengthen and sharpen a firm’s ESG processes and communication. 

Role of chief sustainability officer 

As ESG reporting frameworks such as the Task Force on Climate-Related Financial Disclosures, the Taskforce on Nature-Related Financial Disclosures, and the International Sustainability Standards Board, become widely adopted and aligned for reporting in 2023 and beyond, there is further pressure on asset managers to communicate regularly and be willing to face scrutiny and routine questions with confidence and credibility. 

A major challenge is how to address ESG appropriately and adequately within an organisation. Many asset managers now assign executive officers, sustainability professionals and risk teams to preside over ESG or responsible investing steering committees, with underlying sub-committees or strands. How effective can this steering committee be across different time zones and the fast-evolving environment? 

Just as a well-functioning and robust compliance department serves as an integral part of an asset manager’s operations, so too should firms establish a strong ESG or sustainability department, as opposed to creating “paper policy programmes” with limited monitoring and enforcement. 

As much as chief compliance officers often serve as important advisers alongside chief executive officers and report to the board of directors, there is reason to develop the important role of chief sustainability officer (CSO) to preside over an asset manager’s ESG practices and related risk exposure. 

The CSO would develop robust frameworks, incorporate ESG audits and should be empowered to stop old practices from being greenwashed, to close down non-compliant funds, enforce positive change, and report to the board.

The CSO’s team would be a potent disrupter established to challenge an organisation to think more broadly about ESG issues and compliance with sustainability reporting standards. The CSO needs to be an influencer for change to get the firm to shift its mindset and practices, and to execute the ESG and sustainability policy and practices. Such an influencer needs to have strong communication and persuasion skills. 

Internal alignment 

It is vital for asset managers to discuss internally and to receive feedback from staff as to what they feel are the firm’s ESG priorities, and how to incorporate them within the business and culture. 

To demonstrate authenticity, a firm’s own mission, culture and operations must align with how the team aims to foster real ESG practices, both within the company and from investee companies. 

Those who engage in ESG-related analyses or research should sharpen their skills to better present internally and externally to clients. This is common practice among many asset managers that include key research professionals in pitches and due diligence calls. Oftentimes, members of a research team are asked how they integrate ESG, and therefore it is vital to be fully aligned on the firm’s messages.

The road ahead is long and requires innovation, creativity and resilience. There will always be a need for constant upgrading and refinement. 

Engage, engage and engage

An asset manager’s messages on ESG must address what is important to their stakeholders. 

Through frequent engagement such as community meetings, online shareholder surveys and investor perception studies, managers need to ask questions of external audiences in order to produce a meaningful and responsive report or message. 

For example, how do stakeholder audiences view the importance of economic development efforts as opposed to board diversity? And to what extent do they require both? 

If stakeholders do not wish to be engaged, a manager should try and find out why and what’s missing. 

A common hurdle for fund managers is how to handle questions, challenges or pushback by prospective investors and asset consultants on ESG matters. There are no clear, apples to apples comparisons to differentiate between one ESG-integrated fund’s approach from another.

Investment consultants continue to “size up” asset managers’ ESG convictions by challenging them with recent academic research, or by posing in-depth questions on how ESG is integrated in fundamental research. They expect the asset manager to defend their investment thesis. Therefore, the manager’s team must work well together to prepare effectively for such questions and challenges. 

As long as the asset manager can consistently demonstrate how every idea, every thought process and every practice considers ESG at its heart, they will stand out. 

ESG is like a cross between the rolling thunder-ball in an Indiana Jones movie and the world’s biggest ball of wool. Pull the end of the thread at your own peril as this thunder-ball isn’t going away.

*Manoj R. Dani is director of Odyssey Consultants Limited.