Institutional investors are stepping up efforts on responsible investing (RI). Yet each can define RI differently. Some want to integrate ESG factors into the investment process and be an active owner. Others are looking to use their investments to create a better tomorrow, investing for sustainability and impact. We asked investors in the US, Netherlands and Australia to share their thoughts with you about the opportunities and challenges of responsible investing
What are some of the drivers that have made responsible investing a priority for your organization?
Markus Schaen, Senior Fund Manager, MN (Netherlands): “We believe that our investments have effects on the real world, and we want to take responsibility for these effects. At the same time, we also believe that the real world has an effect on our investments, and integrating these effects is part of the risk/return considerations of our investments. Both the responsibility for the effects on the real world, and the effects of the real world, are part of our fiduciary duty to work in the best interest of the pension funds and their beneficiaries.”
Aeisha Mastagni, Portfolio Manager, Corporate Governance, California State Teachers’ Retirement System (CalSTRS) (US): “We believe that companies that have the gold standard of corporate governance structures and practices are better positioned to perform well in the long run. So we feel the best corporate governance practices actually add value to companies. And we also see our engagement activities as a way to mitigate risk. We raise issues at companies that we think could impact their viability in the long term.”
Jodie Tapscott, Senior Manager, Corporate Responsibility, Colonial First State (Australia): “There have been many drivers for our increasing focus on responsible investing, including shareholder engagement with [parent company] Commonwealth Bank of Australia (CBA) on responsible lending, responsible investment, and CBA’s commitment to the Paris Agreement on climate change. NGO lobbying on various ESG issues and investment exposures, increasing demand and feedback from customers, and our increasing awareness of ESG risks have also been factors. The competitive environment has also been a driver, with peers moving to make RI a priority and growing competition from millennial-targeting, ESG-focused fintech start-ups.”
What is your organization’s philosophy around RI?
Mart Keuning, Advisor Responsible Investment & Governance, MN (Netherlands) : “We integrate RI in our entire value chain, from the strategic investment framework, and the investment strategies we write for every asset class, down to the selection and monitoring of our managers and the active investment decisions that are taken on the floor.”
JT: “Our philosophy starts with an understanding that ESG factors affect the interests of our customers, clients and shareholders, so they must be incorporated into our decision-making. We believe wealth managers have a responsibility to allocate clients’ capital to productive purposes in the pursuit of sustainable long-term wealth protection and enhancement. As a result, we need to play an active role in understanding and applying ESG matters in investing, in order to earn and maintain the trust of our customers, clients and stakeholders.”
AM: “ESG is all about managing risks—whether that’s environmental, social or corporate governance risks, which can have a reputational impact that can result in a financial impact. And CalSTRS is looking at potential risks five to 15 years down the road. The CalSTRS Board is very passionate about these issues, as are the CalSTRS beneficiaries: namely, the teachers of California.”
Describe some of the challenges you have faced in formulating and implementing an RI framework across your investment portfolios.
AM: “One of our biggest challenges is that we have limited resources and there are many issues that our beneficiary group is very passionate about. Nobody wants to take anything off the list, and people keep wanting to add to it! That’s really our biggest challenge—meeting our fiduciary responsibilities while also being responsive to our stakeholders.”
JT: “The biggest and ongoing challenges are addressing team preconceptions, disputing misinformation on impacts to investment performance and risk, and working with narrow definitions of fiduciary duty and best interests duty.”
MS: “One of the big challenges is integrating ESG in passive investments. Due to us being an investment manager mostly for pension funds, strict risk management and liabilities matching are important, and result in a number of portfolios having a passive character. We believe that ESG integration is as necessary in passive portfolios as it is in active investments. However, we need strong and reliable ESG data to base portfolio construction on, and this keeps posing a challenge.”
What are your expectations from asset managers you work with or intend to work with in this space?
MK: “At MN we have an elaborate scoring framework with respect to scoring our asset managers on their RI policy and implementation of the policy. First of all, we want to see that our managers are serious about ESG. Not just talking the talk but also walking the walk. For example, it’s not enough to simply draft a nice ESG policy and to talk about ESG in general, but to distinguish between what is meaningful for us as an investor and what is not. We expect our managers to formulate an ESG policy, specific for the asset class in which we are invested with that manager. We expect sound research on which ESG factors are relevant and material, and a clear strategy for integrating these factors into investment decisions. Finally, we ask external managers to report on the identified ESG characteristics of their portfolios. This all depends on whether the portfolio is an active portfolio, of course.”
AM: “All of our managers have to agree to abide by our ESG risk factor policy, which has about 21 factors listed. It’s embedded in all our investment policies here and it isn’t an exclusionary list. We’re asking our managers to recognize that these are risk factors to a portfolio or to companies, and to ensure that if you’re going to take on one of these risks, that you think you have a valid or commensurate return in exchange for taking on that risk. That ESG risk policy is also embedded into the divestment policy. If a company is violating one of the risk factors over a sustained period of time and we don’t think there’s a way to mitigate that risk, then the divestment policy can be triggered.”
JT: “We expect our asset managers to be aware of the ESG risks and opportunities of the companies in which they invest, and to factor these into their models and investment processes (whether quant or fundamental). We also expect that they measure and track their exposure to these ESG risks and opportunities over time and actively engage on these risks and opportunities to ensure investee companies better manage and/or mitigate them. When asset managers aren’t successful in influencing investee company behavior, we expect them to reduce their exposure to these risks over time. Managers vote all shareholder resolutions actively and not just as per proxy advisor recommendations, especially where an investment process has provided proprietary insights that can be used to inform the vote.”
What are your highest priorities when it comes to incorporating ESG in investment portfolios?
MS: “There are ESG risks that everybody is aware of, but which are at the same time not easy to incorporate. We aim to take action on these risks. Climate risk is a good example: we know that there are climate risks and that will affect investments. Hence, we can never say we did not know a changing climate could affect our portfolios. Therefore, we have to define what those risks are and be prepared to take actions on them.”
JT: “Our highest priorities are to:
- Understand the physical and transition risks of climate change likely to impact our portfolios;
- Measure, monitor and reduce the ESG risks we have exposure to over time;
- Develop, source and offer additional ESG-related investments to our members;
- Improve disclosure and communication to our customers to educate and inform them on our approach to ESG, why RI is important and what investment options are available to them.”
How do ESG considerations fit into your corporate responsibility objectives?
JT: “Our corporate responsibility objectives informed our RI considerations, and they play a key part of the CBA Group’s overall Opportunity Initiatives, alongside responsible lending and responsible procurement as good business practices. More details on this can be found here.”
Where do you believe the future of ESG and RI is heading?
MK: “First, we believe that the incorporation of ESG is a bit behind. Almost every asset manager talks about ESG and sustainability, but some struggle to integrate E, S and G in their portfolios. That is also due to difficulties in the availability of sound data to act on. But data availability and reliability will increase. The real change in perspective on how we invest still has to take place, and we believe it will. This will also mean that integrating ESG will be done not only in active portfolios, but also in passively managed investments. Companies will have to meet a certain ESG bar to be investable, and that could lead to a change in the ESG perspective of companies.
“Second, we believe that going forward, ESG will be more integrated than it is now, also from an organizational perspective. At MN, the RI team is now integrated in the fiduciary advice business unit. This means we are part of the decision-making when it comes to the strategic investment framework and to investment strategies. That will lead to an even more integrated way of looking at RI, a development we believe will eventually take place throughout the industry.”
AM: “Even in the 15 years that I’ve been in the governance space, governance has been an evolution. Things that were common practice in companies just 10–12 years ago are not common practice today. I think that more and more institutions and investors are going to be paying attention to these issues. Look at MBA programs: there never used to be courses about corporate governance, and now there are. We have a student intern program every summer. A lot of the students have a lot of interest in what we, the Corporate Governance Unit, are doing now.
“I think some of the G in ESG is more quantifiable than the S or E, which is why it gets a certain amount of attention. It’s more difficult to measure the E and the S, and with these issues, we want to make sure companies are managing certain risks to their business that may or may not happen at some point in the future. That’s a little harder to quantify.”
JT: “We believe that ESG will become fully integrated into asset management over time. Key standardized ESG and impact metrics will be developed, all investment professionals will have a working knowledge of the ESG considerations relevant to their asset classes, ESG considerations will become fully integrated into investment processes, and asset managers will adopt active ownership practices; voting and engagement will become a normal mechanism.
“There may always be a role for niche and specialist RI-related product, to support specialist asset classes and sectors such as renewables, green bonds and social housing, etc. There may also remain a need for dedicated ESG/RI/stewardship functions to provide specialist research or active ownership expertise, depending on the structure and style of the asset manager and their investment processes.”
“At the moment, we see a much stronger focus on how investors can support the transition to a low-carbon economy and also help achieve the UN Sustainable Development Goals. I think we will see increasing levels of innovation in the way that investment products are developed and structured that will ultimately allow more capital to flow to help deliver some of these broader societal goals.”