The economic shift to overcome global issues has increased the demands from almost all market forces, with part of the accountability falling on the shoulders of those that provide capital.
Consequently, asset managers are increasingly integrating environmental, social and governance (ESG) issues into portfolio considerations and to become forceful stewards of their investments.
SquareWell Partners’ annual study of 50 of the world’s largest asset managers, aims to bring to light how these asset managers are approaching some of the most prominent issues in today’s global financial market.[1] Below we highlight some of the key findings from the study that is relevant for board members to consider:
ESG Becoming Mainstream
Global challenges, such as climate change, biodiversity and societal inequalities, have led to a shift in investor behaviour, whereby incorporating ESG factors in portfolio construction has become commonplace.
By the end of 2020, assets in ESG funds hit a record of almost $1.7trillion, up 50 per cent over the previous year, according to Morningstar.[2] Over the last year, the Covid-19 pandemic further underscored the necessity of building resilient business models, based on multi-stakeholder considerations. Indeed, Morningstar reported 51 out of 57 of its sustainable indices (89 per cent) outperformed their broad market equivalents in the first quarter of 2020, highlighting the benefit of incorporating ESG factors into investments.
The United Nations-supported Principles of Responsible Investment (PRI) has been a driving force behind the growing integration of ESG factors in the investment process. Adherence to the PRI principles, as well as the PRI assessment scores, are now factored into the asset manager selection process of many asset owners. In the study conducted by SquareWell, it was found that all but one of the world’s largest 50 asset managers are a signatory to the PRI. However, it is crucial to look beyond whether an asset manager is a PRI signatory to discern whether investors are in fact taking ESG matters into account in their decision-making processes. Companies can get a clearer picture of an asset manager’s position through their investment and voting policies, public stance on key ESG topics, support for ESG initiatives, etc.
Incorporation of E&S topics into voting policies
Asset managers predominantly focus on governance issues, such as board composition and executive pay, in their voting policies. But are often encompassing of environmental and social (E&S) issues, too, with climate change and human capital sections becoming increasingly common.
The SquareWell study found that 32 of the top 50 asset managers have included distinct E&S guidelines in their voting policy, up from 19 in 2019. Such changes to voting policies can have immediate and tangible impacts on investee companies. For example, in 2017 State Street Global Advisors started pressuring companies to have gender diversity within boards through its Fearless Girl campaign. Three years after introducing the campaign, female board members had been added in 681 companies. The asset manager now votes against all board members on the nominating committee of an investee company in target markets that doesn’t have female members on its board and pressures companies to improve their disclosures on diversity, in all its forms, within their workforce.
Public positions on EGS topics
Asset managers have also increasingly been offering their perspectives on key ESG topics, such as climate change, biodiversity and human capital, through position papers. These position papers provide further substance on their motivations and/or expectations when compared to voting policies, which companies should be aware of.
The study by SquareWell found that, out of the top 50 asset managers, 34 produced position papers on ESG topics, compared to 24 in 2019. For example, nine of the top 50 asset managers published dedicated insights on their increased demand for transparency on portfolio companies’ approach to tax. Guided by the principle that a company’s approach to tax is a board responsibility, investors demand companies publish a tax policy and a country-by-country breakdown of tax payments to ensure that taxes are paid where economic value is generated.
ESG reporting standards
Over the years, many ESG initiatives have emerged. For the study, SquareWell selected several that have seen increasing levels of support by investors.
Despite the prevalence of the Global Reporting Initiative (GRI) for multi-stakeholder ESG reporting, investors have started to show increasing interest in more targeted and material frameworks, such as the Sustainability Accounting Standards Board (SASB) and the Task Force on Climate-related Financial Disclosures (TCFD) of which 27 and 43 of the 50 asset managers supported, respectively.
The high interest in the TCFD was to be expected, given its strong acceptance by the financial sector due to its association with the Financial Stability Board (FSB). SASB, originated in the US and initiated by investors with an emphasis on financial materiality of ESG topics, is gaining global acceptance as it reduces the need for investors to make sense of large amounts of sustainability information, thus reducing the analytical burden. The upcoming merger of SASB and the International Integrated Reporting Council will alleviate the US-centric limitations of SASB and could potentially lead to another boost in uptake.
“COMPANIES AND INVESTOR RELATIONS TEAMS NEED TO DETERMINE WHICH ESG RESEARCH AND RATINGS PROVIDERS THEIR TOP INVESTORS ARE USING AND, WHERE APPLICABLE, WHAT DATA IS USED IN THE INVESTOR’S PROPRIETARY MODELS”
The support of passive giants like BlackRock and Vanguard for both SASB and TCFD has resulted in a spike of uptake by other asset managers not wanting to miss out. While large passive managers may have ‘hard’ requests on reporting frameworks, they do not expect full alignment overnight but expect companies to get the process started of disclosing material ESG topics relevant for their sector. Fortunately for companies there is some overlap between existing reporting standards and frameworks, which helps to assuage some of the reporting fatigue.
ESG ratings – the new influencer in town
ESG research and data providers play a critical role in making sense of the heterogeneous sea of ESG metrics; however, differences in methodologies between ESG ratings providers can result in very different scoring.
To overcome these disparities in ratings, investors are taking into consideration multiple perspectives, with 20 of the 50 asset managers consuming information from at least four ESG data and research providers. MSCI is the preferred provider for ESG research and data, unsurprising given its coverage of more than 14,000 companies and its ability to link their ESG ratings to the creation of ESG indices. To this end, SquareWell notes that MSCI is the ESG ratings provider for 28 (out of 40) of the top ESG ETF products globally (those above $1billion in assets under management).
To efficiently utilise ESG ratings, investors need to select a provider that best aligns with their own ESG strategies. That said, the extent to which ESG information is diluted and standardised by rating providers may reduce its value towards the abstruse edge needed for outperformance in investments. This has led to an increasing number of asset managers looking to develop proprietary ESG ratings and tools, with 30 of the top 50 asset managers having created their own ESG ratings. For example, under Legal & General Investment Management’s (LGIM) Climate Impact Pledge, LGIM focusses on sectors that are considered key to meeting the world’s net-zero emission challenge and companies are assessed using a proprietary model that is fed by five different ESG research and data providers, including CDP.
Companies and investor relations teams need to determine which ESG research and ratings providers their top investors are using and, where applicable, what data is used in the investor’s proprietary models. Companies can then take a top-down approach and map out what ESG factors the market evaluates them on to maximise the alignment of their ESG practices and disclosures.
By Estelle Guichard, Partner – Head of Responsible Investment Research at SquareWell Partners
Estelle’s areas of expertise include corporate governance, shareholder activism and shareholder engagement. Estelle has been advising listed companies on governance issues in Europe for the past eight years after serving as an investor relations consultant for six years, where she developed an in-depth knowledge of the financial community in Europe. She holds a Master’s from Tours-Poitiers Business & Management School.