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ESG Under Scrunity

Lessons from manager selection

Environmental, social and governance considerations continue to rise in importance among the investment community, across all asset classes. Yet, with ESG priorities and principles varying hugely from investor to investor, the fit between fund manager and allocator is by no means straightforward.

For this paper, we looked back at five very recent customised manager searches in public and private markets where ESG played a significant role. Two of these engagements - a Private Debt selection exercise for the UK Environment Agency Pension Fund and a Public Equity search for a European family office - are presented in detail. These asset classes sit at opposite ends of the spectrum in terms of the extent to which ESG has become embedded and marketed. The subsequent discussion draws on insights from other relevant searches in private equity, public equity and even renewable infrastructure during the past three months.

We hope that specific insights drawn from practical examples, as opposed to broad generalities, will be useful for both investors and managers involved in this sector. Many of these lessons relate to manager analysis, or how to dig beneath increasingly sophisticated window-dressing to assess actual practices. Whilst the number of ESG-branded offerings continues to rise across all asset classes, it has become increasingly challenging to distinguish between box-ticking and substance.

Table 1 Asset managers and ESG integration: a universal framework

Overall, the universe of products and strategies continues to shift away from exclusions and screens, towards bottom-up factor integration and active engagement. Indeed, recent press from the likes of CalPERS on the underperformance caused by negative screens is likely to intensify the pre-existing trend. Yet each of these approaches, particularly integration, can take many forms.

Perhaps the most fundamental takeaway from ESG manager selection projects in 2016 is the sheer diversity of demand. Some investors approach ESG from a definitively ethical perspective, others from a risk management standpoint; the variations go on and on. Experiences inform us that the same strategy and team can often satisfy one investor’s ESG requirements whilst falling short for another, making a bespoke approach important. This variation also helps to explain why - as our internal research demonstrates - progress on standardisation has proven challenging, even in listed equity. Customised segregated mandates are still the ‘norm’. This should continue: institutional investors bring deeply held, differentiated views on responsible investment to the table. Yet, at the same time, we do believe there is a subset of investors and asset managers that would welcome some movement towards greater uniformity at policy level, perhaps led by an entity such as PRI.

Table 2 Mandate at a glance

Latest News

• Donald Trump’s victory has had a negative short-term performance impact on portfolios with a sustainable angle, particularly on the environmental side and most notably where the companies are early-stage and developing innovative technology. Yet the longer-term picture is unclear: Trump has not clearly indicated that U.S. government-backed ESG-related projects or bodies will be in the firing line.

• More than 125 active global equity managers now offer an ESG-oriented product. Of these, nearly a quarter (23%) have a track record shorter than three years and 70% under 10 years after a decade of remarkable proliferation. In comparison, nearly two thirds of traditional active equity offerings present track records of more than 10 years.

• The number of PRI (Principles for Responsible Investment) signatories has exceeded 1600 for the first time, with 223 joining in the year to April 2016. According to PRI, the AuM of investment manager signatories represents three quarters of total investment manager AuM worldwide; the proportion on the asset owner side is much lower.

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