To integrate ESG considerations into their externally managed assets, asset owners (or their investment consultants) will assess external managers’ integration practices.

They do this through their existing selection, appointment and monitoring (SAM) process in order to identify, hire and appraise managers that will be able to comprehensively meet their mandate. To do this, asset owners need a good understanding of the manager’s investment approach and performance, risk management, stock selection and portfolio construction decisions.

As ESG integration techniques vary widely (See ESG integration techniques), it is important for asset owners to define what ESG integration means to them in their investment strategy, policy and SAM process. This enables asset owners to evaluate external managers that meet their expectations for the level and style of ESG integration applied to their portfolio, and allows investment managers to clearly understand those expectations.

When interacting with managers, an asset owner must tailor their expectations according to various characteristics.

Location

  • ESG integration is not uniformly applied across the world. For instance, North American managers do not typically use the same integration techniques as European managers.

Size

  • Smaller firms may have fewer responsible investment tools and staff to integrate ESG factors into processes, and so cannot be expected to have the same ESG offering as larger firms. Alternatively, some smaller firms are responsible investment specialists and therefore particularly well-equipped.

Style

  • Different investment styles can have different integration techniques and different ESG risk characteristics. For example, a value manager can invest in companies that have been assessed to have previously performed badly based on ESG criteria but are now showing signs of improvement and an opportunity to generate alpha. If the manager holds a significant number of companies that have a poor but improving ESG performance, the ESG risk of the portfolio could be high.

ESG experience

  • Managers that have only recently started to incorporate integration practices may offer less than managers that have been doing so for longer, but the respective managers f intention to continually develop their integration practices is important in the long term.

A two-way dialogue

Investment managers should play their part in discussions by proactively asking about their client’s investment strategy and policy, their integration practice expectations and the integration practices of their other external managers.

Example questions:

  • What, in depth, is the rationale behind your investment strategy and policy?
  • What are the most material ESG issues and themes that impact your whole portfolio? What drives materiality? What are your views and expectation on them?
  • To what extent do ESG factors play a part in the manager selection and monitoring process?
  • What are your integration practice expectations of your investment managers?
  • What information do you require on our investment process, integration practices and investment decision-making?
  • What information, including regular reports, do you require about the portfolio holdings?
  • Do you expect your investment managers to integrate ESG factors into their valuation models?
  • Do you monitor the ESG risk exposure of your portfolio?

Managers should also keep up-to-date on changes to their client’s requirements, such as around investment strategy, policy or other changes that could alter their operating environment. Reporting timeframes could determine the depth of the discussion, e.g. investment policies do not change very frequently, whereas elements within the operating environment may.

Example questions:

  • Has your investment strategy or policy changed?
  • Has your operating environment changed, resulting in material changes to the investment scope?
  • Do you have any examples of ESG integration best practice from other managers?

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