As providers of capital, asset owners sit squarely at the top of the investment chain.

There are five distinct barriers to asset owners taking a more proactive approach to responsible investment:

It is possible to trace the root of many of these barriers back to weak implementation of responsible investment at the start of the investment chain – by asset owners. To break this cycle, asset owners need to properly integrate responsible investment into their investment beliefs, governance and mandates.

The perception that ESG issues do not add value to investment decision-making

The interviews conducted for this research suggest that investment professionals place much greater weight on experiences from their own careers than they do on thirdparty evidence and research. Asset owners beginning responsible investment activities and looking to ensure that ESG issues are integrated into their investment practices and processes therefore need to build their own internal evidence base: as ESG issues are analysed and taken into account, asset owners can gather evidence on whether and how this integration contributes to investment performance. This evidence can then be critically reviewed so that the impact is understood by the organisation as a whole.

Investment practitioners look to learn from, and often seek to follow, the practices and experiences of their peers. Interviewees commented that simply showing other asset owners how they integrate ESG issues into their investment processes and demonstrating the investment benefits that result is an important role for asset owners to play.

We recognise that, in some areas and some asset classes, the investment market’s approach to responsible investment is immature and that we may not be able to find the exact product that we are looking for. In these areas, we look to find managers that we can work with, even if they don’t have all the skills/capabilities at the beginning.

Our experience is that, over two to three years, the demands that we make (e.g. on reporting, on product development) drive real change within investment managers. We find that they do strengthen their reporting, they do build their capacity and capabilities, they do place more emphasis on ESG issues. Encouraging these changes, however, takes time. It requires us to commit resources to monitoring our investment managers, and to engaging with, and providing regular critical feedback to, these investment managers.

Mark Mansley, CIO, Environment Agency Pension Fund

The perception that significant additional resources are required to implement responsible investment

Asset owners can address this barrier by ensuring that their approach to responsible investment is consistent and complementary to their wider investment and organisational objectives. Specifically they should:

  • have an explicit statement on ESG issues in their investment beliefs and ensure that these beliefs are shared in an open and transparent way with beneficiaries and with investment professionals and other key decision-makers within the organisation;
  • focus on those issues that are important to the organisation (i.e. legal obligations and organisational goals) and identify the relationship of these issues to ESG;
  • ensure that they use or build on their existing investment processes to deliver and implement their investment beliefs – ESG issues should be seen as just another set of issues to be considered in investment research and decision-making;
  • understand responsible investment-related costs in the context of the investment and other benefits that are likely to accrue, making the identification and management of ESG-related issues an integral part of investment risk management processes (for example, well-thought out beliefs help the asset owner to better understand the investment risks taken by the fund and by its agents, which can feed into decisions on selecting and retaining managers).

“Our internal investment teams support the work of the corporate governance team and they acknowledge that corporate governance engagement and voting are integral to good investment practice. This engagement and voting is particularly important in passive funds, where we effectively hold investments to maturity.”

Jacob Williams, Corporate Governance Manager, State Board of Administration of Florida

The perception that investor duties, and in particular, fiduciary duty, prevents investors from taking a proactive approach to responsible investment

To address these, asset owners have three roles they can play:

  • Analyse and take account of ESG issues in their investment processes while also ensuring that they have robust processes to:
    • record the analysis that they have conducted and the actions that they have taken based on this analysis;
    • assess how these decisions have influenced investment performance;
    • review processes to analyse how ESG issues have affected investment performance .these should include critical review of analytical methods, assumptions and decision-making processes.
  • Press regulators to clarify that asset owners’ fiduciary duties require them to pay attention to ESG issues in their investment processes, and to actively engage with companies and issuers on ESG issues.
  • Challenge their investment consultants and legal advisers to ensure that the advice being provided on fiduciary duty takes account of ESG issues.

“The argument that ESG issues are important to financial and investment risk, and not just about ethical investment, is increasingly recognised in the investment industry. In contrast, however, much of the legal profession is well behind the curve, thinking that ESG issues cannot be relevant to their investment clients and that to take such issues into account may even run counter to their fiduciary duties. There is clearly a need to move legal thinking away from the perceived dichotomy between being ethical and achieving the best returns, and shifting focus instead onto the importance of ESG considerations as a key financial factor for investment decision-making. Looking at it that way, the fiduciary duty looks rather different, and the argument that ESG issues should be taken into account becomes much more compelling.”

Mark Womersley (Partner, Osborne Clarke LLP; legal counsel to Environment Agency Pension Fund

The advice given by investment consultants, which is often seen as not supporting proactive approaches to responsible investment

Investment consultants say that asset owners rarely raise responsible investment issues with them, which makes them less willing to raise responsible investment with their clients, and limited their willingness to integrate responsible investment into their mainstream service offerings.

When appointing investment consultants and legal advisers, asset owners should ask them to explain how ESG factors and responsible investment are integrated into the advice that they provide. Asset owners should also ensure that ESG issues and responsible investment are standing items in consultant meetings.

“In the South African investment system, investment consultants are the key actors. Many asset owners rely on their consultants to bring relevant issues to their attention. However, most consultants are not actively supportive of ESG or responsible investment and so, in the absence of explicit demand from their clients, tend not to proactively raise the issue.”

Isaac Ramputa, Chairperson, Batseta

“Investment consultants see ESG as one set of skills/competencies that an investment manager might bring to the table.”

Nico Aspinall, Head of UK DC Investment Consulting, Willis Towers Watson

The products provided by investment managers, which often do not meet the responsible investment needs of asset owners.

Asset owners need to be clear that they expect their investment managers to analyse and take account of ESG issues in their investment processes, in their active ownership activities, and in their public policy engagement. Asset owners need to explain how these are incorporated into manager selection, appointment and reappointment processes, and how they are incorporated into investment mandates.

They should require investment managers to report regularly on how they have taken account of ESG issues in their practices and processes, the investment decisions that have been made as a result of ESG integration, and how this has affected investment performance.

Asset owners should provide feedback to their investment managers on how they are performing against asset owners’ beliefs and policies and they should encourage investment managers to continuously improve their practices and processes.

High-performing investment managers (in terms of product development, quality of ESG integration and quality of company and issuer engagement) should be rewarded, whether through strengthened relationships with existing clients or through winning new mandates.

“The CalPERS side letter requires investment managers to incorporate environmental, social, and governance factors into investment processes and report on those factors on a regular basis, in addition to responding to any CalPERS questions related to the same.”

James Andrus, Investment Manager, CalPERS

“There has been an evolution over time with respect to our managers’ attitudes and capabilities on responsible investment. Today almost all managers can demonstrate how ESG integration fits with their investment philosophy, strategy, and practices.”

Katharine Preston, Senior Manager, Responsible Investing, OPTrust

“Investment managers will be led by what their clients ask of them, by wider market demand, by regulatory drivers. There may also be an evolution in legal thinking, in particular in relation to fiduciary duty, which puts further impetus behind this agenda. Concerns about the long-term impact of climate change and recognition of its materiality to investment outcomes may well be the catalyst.”

Mark Womersley, Partner, Osborne Clarke LLP; legal counsel to Environment Agency Pension Fund

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    How asset owners can drive responsible investment: Beliefs, strategies and mandates

    March 2016

How asset owners can drive responsible investment: beliefs, strategies and mandates