Recent events such as the horsemeat scandal, the collapse of a textile factory in Bangladesh, the US court case against BP and the revelations about banks rigging the Libor rate illustrate all too clearly the importance of environmental, social and governance issues to investors.
And it would appear that investors got the message. Since its launch in 2006, more than 1,100 institutions representing roughly $32tn of assets under management have signed up to the UN’s Principles for Responsible Investment, which encourage investors to incorporate sustainability issues into their operations.
Great progress has been made, says Neil Brown, a socially responsible investment analyst at Alliance Trust and chairman of the PRI’s ESG integration working group. “There is some very good work being done in a volume, quality and depth that is staggering compared with where we were four to five years ago.”
There has been a transformation in how asset managers, particularly in Europe, pay attention to these issues, agrees Vicki Bakhshi, head of investor engagement at F&C. “There is a greater realisation that poor corporate governance or a lack of environmental controls can lead to poor performance. These are issues that are material to the performance of companies in the long term.”
However, in itself, PRI membership is not enough. “It’s great that so many people have signed up to the PRI, but in our research, just 9 per cent of investment strategies are performing really well on integrating ESG issues into portfolios. It shows that signing up to the PRI does not mean you are integrating ESG measures. It is just the first step,” says Aled Jones, head of responsible investment at Mercer, the consultancy.
Many in the industry agree that while things are better than they were, there is still a long way to go. The main barrier is the attitude and understanding of asset owners such as pension funds, says Will Oulton, head of responsible investment at First State Investments. At a recent investment forum held by First State, 65 per cent of those present said that what would accelerate ESG integration by asset managers the most was a stronger mandate from asset owners.
“If you are a large, successful asset manager, why would you change your business model if there was no pressure to do so?” asks Stuart Kinnersley, European chief investment officer at Nikko Asset Management and portfolio manager of the World Bank Green Fund.
“Asset owners have a huge role to play in this, but many pension fund trustees still believe that ESG means ethical investing, which they believe will depress returns,” Mr Oulton adds. “But the truth is that mainstreaming ESG is just sensible investing.”
Philippe Zaouati, deputy chief executive of Natixis Asset Management and chief executive of the firm’s Mirova socially responsible investing funds, the second-largest in Europe, says that there is room for both SRI and ESG in mainstream investing.
“ESG integration is a good thing and it is needed, but to completely erase SRI would not be positive.”
Natixis, which has €280bn of assets, integrates ESG into all its portfolios and reports on its ESG engagement to all clients. However, it maintains Mirova as a separate SRI unit that focuses on eight sustainability investment themes. “There is a difference between integrating ESG and seeking to create an impact,” Mr Zaouati says.
To get to the next stage – where integration becomes substantive – “asset owners that care about this need to start asking some probing questions of asset managers, such as what resources and expertise they commit to ESG and at what issues they look”, Ms Bakhshi says.
Answering such questions is becoming easier as the amount and quality of ESG data improves. It is also due to to initiatives such as the International Integrated Reporting Committee, which is encouraging companies to incorporate ESG issues into their annual reports, and the UK’s Stewardship Code, which calls on investors to consider ESG issues when applying equity mandates.
The trend for increased integration will continue, believes Alliance Trust’s Mr Brown, because “there is increased demand from the buyside – and they demand it because they believe it will drive returns. You will see more and more companies just getting on with it.”
One example of this is the work being done by Axa IM, which uses ESG factors to help formulate its approach to sovereign debt. It has carried out a more detailed 18-month pilot project researching the most meaningful ESG issues in its UK equities portfolio. “The UK equities team now ask specific questions about ESG,” says Matt Christensen, head of responsible investment at Axa Investment Managers.
“The answers are collated and used to create a scoring system that ranks companies. That rank tilts the portfolio towards companies with higher scores and also identifies the companies the team needs to engage with to get them to change their behaviour to improve their performance – and therefore our returns.”
The programme is now being rolled out across the company’s operations in Europe, Asia and the US over the next two years. “We are seeing more and more pension funds asking for this information. In five years’ time, things will look very different. But this is not something that you can change overnight,” says Mr Christensen.