Despite being on the agenda of almost every pension fund and asset manager, there is a marked lack of consensus on SRI. Giovanni Legorano reports
Under the auspices of the United Nations Secretary-General, a working group of the largest institutional investors developed the United Nations Principles on Responsible Investments (UNPRI), aimed at suggesting possible actions for incorporating environmental, social and governance (ESG) issues into mainstream investment decision-making and ownership practices.
This initiative, governed by an elected board of 11 representatives mostly from pension funds from the five continents, is one of the most comprehensive attempts to set down in words how such investment conduct should be structured.
Sagarika Chatterjee, associate director, governance & sustainable investment, F&C, said: "There are about 20 different definitions out there on SRI. In summary, what they mean is that asset owners and asset managers have an active approach towards ownership and look at ESG issues for their investment analysis. For our approach we look at the UNPRI; this is our starting point."
Along the same lines, Jamie Cumming, head of SRI, Aberdeen Asset Management, commented: "If you speak to different people on the subject, you will get different responses. Engagement and integration of UNPRI, ESG and so forth ultimately comes down to combining financial objectives with values and concerns on specific issues."
In terms of regional differences, any conclusion would be approximate, but Christoph Butz, sustainability expert, Pictet Asset Management, tried to delineate differences across some markets: "The consensus on ESG is universally held around Europe, but in France, Italy and Spain social aspects are more important culturally and environment [ones are] slightly less important. In the German speaking world, the environment is generally more important, while in the UK, both aspects seem to receive the same level of attention. However, these preferences are rather just different weightings of the secure criteria which form the hardest consensus."
Butz pointed out the US was at a less advanced development stage than Europe, but also highlighted it could be very effective when it put its mind to it, such as in the area of green technology.
Incorporation and implementation
The way pension funds incorporate the different principles in their investment strategy includes exclusion (or negative screening), positive screening and engagement.
Tim Currell, senior investment consultant, Hewitt, explained: "The vast majority of pension schemes really struggle with any form of negative screening -' excluding a particular sector or company from their investment universe -' because they think their fiduciary responsibility means choosing a particular investment only on the basis of financial considerations."
Clark McKinley, spokesperson for CalPERS, explained the pension fund sacrificed unquantified earnings by divesting from tobacco companies. He said it divested to avoid the risk of potential litigation and diminished share value resulting from litigation. While its constitutional mandate was to maximise investment returns, CalPERS found that 'advocating for good' would have a beneficial long term impact on share value, at least by strengthening the foundation of the economy. In particular, in the environmental sector, CalPERS issued a joint report in 2007, along with CalSTRS, giving examples of how harmful environmental practices could diminish share value.
In Europe, David Russell, co-head of responsible investment, Universities Superannuation Scheme (USS), commented: "We don't choose SRI funds, but we try to integrate these issues across our different asset classes, so we don't have a niche SRI pot but look at these investments in two ways. We first look at how we can integrate them into investment decision processes and then, when there are changes needed to the actions of the company, we would directly engage with them.
"We meet companies all the time. We focus on specific issues where we see there is an issue or an opportunity, as USS believes it should be an active owner. Most of this engagement is undertaken in private."
Positive screening is an approach increasingly adopted by pension funds according to Butz, who explained: "Positive screening criteria imply trying to identify actively which the sustainable companies are and what makes a company sustainable from an ESG point of view. Then, you try to actively overweight them in your portfolio."
Dealing with such intangible aspects of investment has led the different players to search for a quantitative approach to benchmarking both asset managers and companies in terms of their ESG performance.
In response to this, research company RImetrics recently launched an industry benchmark to allow pension funds and other asset owners to evaluate, monitor and benchmark individual asset managers' strengths and weaknesses in responsible investment practice.
Jonathan Horton, co-founder & CEO, RImetrics, commented: "Pension funds need to have good credible data about managers in order to have a proper and constructive discussion with them about strengths and weaknesses. The data is fundamental for managers as well to understand where they are versus their competition."
But, he added: "The key question is why managers cannot take the knowledge that they gain from RI activities and integrate it into investment management practices. This should be, at least, a concern for pension funds. We found that managers are definitely better at 'talking the talk', rather than integrating their knowledge from engagement into their investment management practices."
While traditional monitoring does not take into account SRI, a meaningful integration of SRI principles in investment strategies applies not only to the selection of asset managers, but also to direct investment into companies.
Hewitt's Currell pointed out the importance of assigning a rating to companies regarding their exposure to the different areas of ESG. He explained: "The point for us is very much about empowering the trustees to actually understand what the manager is doing. We think the issue is not about criticising a manager for holding a specific company, but rather it is about questioning the manager to find out what makes a company so attractive, especially in light of these 'intangible' risks. It is very much about the trustees understanding the risks of the portfolio and not just the financial risk."
Questionnaires, data gathering and face to face meetings are standard tools used by asset managers in the monitoring of compliance to SRI. Craig Metrick, US head of responsible investment, Mercer, acknowledged the difficulty involved in comparing different types of managers, but said there were aspects that could be assessed.
He explained: "We have a process based on a four-factor framework. At the strategy level, we look at how ESG factors play a role in portfolio construction and we monitor looking for evidence [of this from] the management."
Alongside similar evaluation methodologies, Chatterjee said F&C also employed an independent ethical committee and an independent research provider to monitor its portfolio.
While there is widespread agreement further development is taking place in this field, with the ever-increasing integration of SRI criteria into both investment decisions and monitoring, there is noticeably less consensus on where we are heading.
On where we currently stand, Metrick commented: "I don't think we have seen the peak yet, it is likely to continue. Not every fund manager is there yet, but the response from both managers and pension funds has been positive."
Pointing out a specific evolution in the composition of pension funds' portfolios, Butz said: "As with many institutional portfolios today there are core assets and satellite assets, we will see a core SRI approach for a large part of pension funds' assets and theme satellite allocations to complement the core ones."
Taking a long term perspective, Currell saw a key role being played by pension funds: "It will become a natural part of the evaluation managers do, driven in large part by trustees' interest, as trustees are challenging managers on these issues more and more and will continue to do so."
Performance considerations will not discourage pension funds from requesting SRI compliance, several players highlighted. Cumming pointed out: "[The] long term performance of our SRI performance is reasonably similar to our portfolio which doesn't have any SRI criteria. We think that as long as you buy the stocks of good quality companies at proper valuations, they should generate the appropriate returns in the same way of an unconstrained portfolio."
Going further, Metrick commented: "We actually like to think in the long term there is a positive impact on performance and we believe there is increasing evidence of it. We don't think there is an impact on long term risk-adjusted performance. We treat RI strategy as close as we can to other investment strategies, because it is how the strategy is executed that makes the difference and whether the strategy is the right one."
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