Company: Auriel Investors


Category: ESG Research Report of the Year (shortlisted)

In the spirit of showcasing leadership and raising standards of responsible investment among all our signatories, we are pleased to publish case studies of all the winning and shortlisted entries for the PRI Awards 2019.

See the full list

Project overview, objectives and why the research breaks new ground

Auriel Investments devised a way for asset owners to ‘look under the hood’ of sustainable - fund strategies to see if their ESG credentials truly stack up. The research was inspired by the need for a practical, accessible, universally applicable impact measurement tool that investors could use to support their decision making.

In setting about achieving this, Auriel used a set of common sustainability measures to analyse the publicly disclosed holdings of 25 funds benchmarked to MSCI World and marketed in the UK as best - in - class ESG integrated funds. While there are other existing methodologies that rate funds on ESG, they mostly rely on proprietary rating methodologies that do not correlate between different providers.

These methodologies are calculated as a weighted average of company ESG ratings - those ratings being industry - relative and materiality - driven - resulting in some famously counter - intuitive scores: some funds well - known for their keen focus on ESG scored badly, while others with zero interest in sustainability, scored incredibly well.

Auriel’s approach was different. It calculated the active exposures of the funds against their shared benchmark across 14 commonly accepted sustainability measures. These measures did not require subjective judgement to calculate, and are applicable uniformly across industries and geographies. The exposures were summarised into a ‘net impact number’ for each fund. This number is the proportion of the fund’s tracking error that its sustainability exposures account for.

This approach does not require rating individual issuers, thus removing a lot of the subjectivity and complexity of existing methodologies. It also focuses on sustainability, with no qualifiers, and so remains undistorted by industry relativity or ‘blindness’ to certain externalities on account of lack of materiality.

The result of this exercise demonstrated that investment products that are marketed in very similar ways as to their ESG approach, using very similar language, in fact differ significantly between each other, both in terms of overall out - or underperformance against the benchmark on common sustainability measures, and their exposures to individual sustainability factors.

In the sample, Auriel found funds that were overall much more sustainable than the index, and ones that were es sentially no different from it or even below benchmark. The funds also all differed from each other in terms of what their strengths and weaknesses were, despite some ‘consensus’ points across the sample.

Report methodology

In this study Auriel measured the sustainability of 25 funds compared to their shared market benchmark. The Impact - Cubed model is built to measure the active exposures at portfolio level to 14 sustainability factors. These factors were selected in part for their universal applicability and availability and are calculated (or estimated) for every listed company globally so that the analysis did not suffer large data gaps. The objective of this set of 14 factors was to give a broad overview of the sustainability of a company. This meant combining both product alignment with the UN SDGs (positive and negative) and operational sustainability in one model.

The process of building the model and selecting the measures took five - years and involved industry consultations across three continents with diverse groups of investors and academics. The UN’s SDGs they have become a guiding framework for the model.

As a result, Auriel has included 14 measures across several categories.

  • How the company uses natural resources: carbon, waste, and water footprint.
  • How the company is governed: executive pay ratio, and board diversity and independence.
  • How the company interacts with society: employment and economic development impact, water use in water scarce localities, and tax gap.
  • Whether its products and services are aligned or misaligned with the UN SDGs: revenues from environmentally and socially good and harmful products and services.

The portfolio level value for each measure is the weighted average of its holdings’ values for that factor. Auriel calculates the net impact number for a fund by quantifying the basis points of tracking error accounting for the fund’s active exposures, where it is outperforming the benchmark, separately from those where it is underperforming the benchmark, an d netting out these numbers.

What this net impact number shows is how much the portfolio is actively shifting capital away from less sustainable practices and towards more sustainable ones, hence pushing the needle from the status quo (market benchmark).

Under this model a fairly light touch ESG - integrated portfolio (or a tilted passive ESG strategy) would have a low impact number, while one with more aggressive active exposures that have ESG and impact characteristics would return higher figures.

How the findings have been applied and the wider benefits to investors

The findings from this paper have sparked a lively discussion in the responsible investment community, not least because it offered a data - driven, quantitative basis for the argument that green-washing (and more recently SDG - washing) is not only an issue for companies but now also investors.

There’s been a boom of investment products marketed as having sustainability or impact characteristics, and together with a dearth of accessible, transparent, objectivity - and - data - focused tools to verify marketing claims, the temptation can be to exaggerate.

In a less headline - grabbing way, however, showing the true variety hiding underneath a fairly uniform ‘best - in - class ESG integration’ tagline for 25 real - world funds invites asset owners especially to ‘look under the hood’ of sustainable strategies to see if the actual positions held are aligned with what the owner’s priorities are, and what is being communicated to them, both in terms of how active the strategy is, and in what areas.

The practical applicability of the model has already been demonstrated. For example, the Church of Finland used this methodology as an input in their RFP process. The asset owner in that context was able to use Auriel’s mod el to consider well - established, quantitative metrics such as tax gap, or waste footprint, to supplement its decision - making.

It is a practical way to carry out a robust sanity and compatibility check for the asset owner with metrics they are already familiar with, and have an intuitive understanding of, without the need to understand complex methodologies and worry about accounting for their inherent biases.

The paper is also effectively proposing a fund sustainability and impact - reporting framework for asset managers that is easy to adopt and has the benefit of using no proprietary research, but rather commonly accepted and well - established measures verified through industry consultations.

Anyone can either procure the individual data inputs from their preferred sources or gather the data themselves and reconstruct the model from scratch.