In the second of a two-part insight, Jon "JB" Beckett, director emeritus at the Association of Professional Fund Investors, Transparency Task Force ambassador, and author of #NewFundOrder, shares insights on the emergence and threat of greenwashing to the investment industry, as outlined at an Ethical Finance Hub seminar.
As asset owners it is alluring to think we are doing enough, the industry is doing enough, that our asset managers are doing enough but that's a cognitive bias that hinders action. it encourages patience, pace, procrastination. Like the whitewashing of ethnic inequality and racism, greenwashing is a way to project contentment, to project that all is in hand. That the problem has a solution, just wait. Ignore the radicals. Trust the industry and we'll get it done goes the CEO platitudes and pontification.
Zandbergen (see Part 1: https://www.investmenteurope.net/opinion/4004095/esg-fund-selectors-cut-greenwash-gradualism) says: "Fund providers must apply more transparent, integrated thinking to determine sustainability. Our structured, active ownership approach tackles the themes investors have not even considered, providing forward-looking expertise that tracks the progression of companies."
Another form of greenwashing is for an asset manager to take an existing product; centralise and integrate its ESG then rebrand the same product with ‘ESG' and then charge a premium. In reality the differences to the legacy products might be minimal but the costs are not. My own view was that I wasn't prepared for my customers to take a hit in terms of cost or outcome for expressing an ethical or environmental need.
This all poses a very real challenge for fund selectors, whether to select managers with exclusion policies or indeed to apply exclusion policies themselves. Greenwash is happening at various levels, from CEO, marketing, investor affairs and media. It's also happening inside the asset manager, on committees and internal discussions.
Meanwhile more and more asset owners are becoming signatories in their own right rather than delegating this to asset managers. The most adopted being the UN Principles of Responsible Investing (PRI). I often naughtily refer to the PRI as having used a ‘Crack Cocaine' model: first making being a signatory easy and free before making it more difficult and costly to comply. Going cold turkey on PRI may prove difficult for signatories. The PRI is becoming more evidential but there is still a lot of room to allow asset managers to greenwash submissions in order to receive a higher rating. How fund selectors deal with this is again another challenge ahead of us.
In 2017 the requirements to retain the highest PRI rating became a lot tougher, and the questionnaire became more evidential based. Like the cursed Sisyphus, of Greek mythology, eternally pushing a boulder up hill, asset owners who are signatories have seen a significant increase in requirements around the selection, appointment and monitoring (SAM) of fund managers. This includes ensuring a minimum of 50% of assets held has integrated ESG, as well as changes to the fund manager selection process.
Building your SAM framework
It is important to note that ESG or Ethical considerations does not mean foregoing investment analysis or due diligence. There are other risks other than ESG. The question rather will be how to incorporate ESG and ethical factors into an existing SAM framework - also given the different SAM approaches commonly used and how these respectively have an impact on integration.
There is a lot written about the merits of different types of fund analysis that underpin a SAM framework and there is no universally agreed approach.
To recap, there are two main schools: quantitative and qualitative. The quantitative approach is much more likely to run an ESG screen alongside. A qualitative SAM approach is more likely to integrate.
To understand the two schools of thought in terms of fund selection is to understand their origins, which are very different. To know them helps integration in the SAM framework. Most asset owners employ a combination of financial analysis and qualitative assessment. If there is no one right way to do fund selection, how then best integrate responsible investing (RI) policy into fund selection, appointment and monitoring framework?
If operating an ESG screen independently from an existing SAM framework then it may be possible to make fewer changes and effect the RI policy more quickly, but there will always be a tension with investment factors and it will be harder to narrate how the RI policy is impacting fund selection decisions unless making a sweeping raft of changes.
On the balance of quantitative or qualitative approaches then my experience is that an RI policy integrates better with a qualitative approach, but can get messy and hard to articulate back to investors without sounding like greenwash. Quants tend not to like to play with others. It does not integrate well, and many asset owners are wrangling with how to incorporate financial and non-financial metrics. However, if applied as a stand-alone screen then this offers the cleanest and most objective approach.
Why engagement is so important to your SAM
If integrating at a high level, then it is possible to dial up or down the weighting towards ESG factors. This can be the most transparent. If dialling down the weighting then there is a risk of diluting the RI policy. If integrating at a more detailed level then arguably it is possible to effect better integration, but with less transparency for investors.
View then, engagement with asset managers as part of the SAM framework; information gleaned continually feeding back into the assessment of the manager. Most likely, initial engagement with asset managers will be focussed around fact-finding, meeting key staff involved with the firm's ESG approach and early conversations with the stewardship and portfolio managers.
This will quickly move onto specific processes, positions and application of ESG into the funds intend for investment in or already held. This will be a combination of meeting the managers and ESG teams, issuing and reviewing due diligence questionnaires, reading manager research papers, cross-referencing ratings and open letters issued by the asset managers. The focus will shift towards sectors and companies the asset manager is positively positioned towards, sectors and companies they screen out or have divested from, and lastly for assets held, how they engage with companies and exercise their voting powers.
Many asset owners lack the research resources of their asset managers, so how can the asset owner benefit from that resource without becoming too tied to just one view?
By engaging a number of asset managers on the same topic, at the same time, both sharpens the fund selector's due diligence as well as gauge their positions, differences between asset managers, identifies thought leadership on specific stocks or issues, and in turn assesses the quality of manager responses.
Whilst the brochures and marketing often reads similarly; in practice the process will identify variance both in terms of individuals, policy and portfolios. These differences will help inform assessments of the ESG integration of each asset manager. Appreciate then, that ESG integration will occur in a few different ways:
- Creation of an ESG team to implement change and conduct ESG research.
- Creation of a stewardship team to manage the firm's engagement policy with companies, proxy voting ... or else outsourcing to the likes of ISS or Hermes EOS on their behalf. Firms are assessed for being activist or having a hold and engage approach to stewardship and key issues.
- Adoption of ESG risks into the firm's enterprise risk framework will change the firm's appetite to hold risks arising from controversy stocks or the likes of climate change. This may also include inclusion in the firm's investment risk framework and governance. Fund selectors are looking for risk having a demonstrable effect on decisions. Some risk functions are at best advisory; few are set up as 'policemen' but the selection process is looking for risk to gauge the ability to intervene. Meeting the risk team is encouraged.
- What systems has the firm bought in or created to measure fund footprint for carbon, GHG (green house gases), etc? For example, Blackrock updated Aladdin to include MSCI data, and Schroders and Investec have developed proprietary tools. If looking to footprint assets held then managers need to have the data to provide that through to the fund selector, or it may be necessary to contract an own system and upload stock positions oneself.
- Application of the firm's RI policy into the investment research and portfolio management process, and evidence to support both in the process/ research system itself or in the portfolios. Look to join the dots.
- Collecting evidence that the firm's overall culture is aligned to their RI policy and that of the fund selector. Looking at issues such as diversity and remuneration. Firms such as PeopleNet are now actively working with asset owners and asset managers to ensure the firm's remuneration is well aligned to its ESG and responsible investing policy.
One area often overlooked by asset owners is the facilities and buildings and staff management: is the firm ISO 14001 Environmental Systems compliant?
Asset managers do a lot of talking about the companies they invest in, but are less open about their own operations and facilities. This requires the asset owner to think about the asset manager as an investor, but also as a business. Do not expect fund managers to know much about their own facilities, so one shortcut is to check if the asset manager has ISO 14001. (ISO 14001:2015 specifies the requirements for an environmental management system that an organization can use to enhance its environmental performance. ISO 14001:2015 is intended for use by an organization seeking to manage its environmental responsibilities in a systematic manner that contributes to the environmental pillar of sustainability.)
From there the fund selector can begin to ask if the asset manager is trying to reduce its own footprint and is it promoting social equality and good governance from the board level down to the mailroom. It is an interesting time; we are seeing moves to set diversity targets on company boards and create diversity indices like FT. For example, the manager research team at Willis Towers Watson in 2018 began to target ethnic and gender diversity in the fund managers they select.
Conclusion - SAM Shortcuts?
What is becoming clear is that there is a whole lot of work to understand asset managers and to apply into the SAM framework. Between one to five managers is manageable, but 10, 20, 30... is much more difficult.
Many asset owners have to do much more than just maintain the SAM framework, they are often involved in relationship, commercials, client facing, portfolio allocation and a plethora of projects. Asset owners at all levels are usually time-constrained and so need to look at research shortcuts to help scale their SAM framework. Using an external agency or rating service is one way to reduce the research burden. This both scales the fund selector's due diligence, footprinting and ESG ratings, but can also facilitate focus on key issues of asset managers - the third party research can focus those conversations.
To read Part 1 of this article click here: https://www.investmenteurope.net/opinion/4004095/esg-fund-selectors-cut-greenwash-gradualism
InvestmentEurope is hosting its Pan-European ESG Summit Vienna 2020 on 18-19 June. Greenwashing and other facets of ESG will be on the agenda. Further details will be announced in the New Year.