Methodologies, data, and reporting: key drivers to meet our clients’ needs
In this article, we consider how asset managers can help their clients meet their responsible investment requirements, by exploring a selection of the key challenges and considerations in this area.
A wide variety of approaches
In the wider world of responsible investment, terms such as ‘sustainable investing’, ‘ethical investing’, ‘ESG’ and ‘impact’ can often be conflated. And yet, while there are commonalities, there are also key differences in these approaches.
With its roots in the nineteenth century, ethical investing has traditionally involved excluding certain sectors, such as tobacco, alcohol, weapons, gambling, and pornography, in line with investors’ values. As a more recent phenomenon, ESG investing is an extension of risk management, involving the integration of environmental, social and governance (ESG) criteria alongside, or within, financial analysis. While it may be combined with exclusions, ESG analysis primarily offers another lens through which investors can analyse the risks and opportunities around a company, by considering its sensitivity to issues such as climate risks and supply-chain disruption.
Sustainable investors also consider the ESG credentials of investee companies. However, they are concerned not only with the risks to the company, but also the outcomes of its operations (this is known as ‘double materiality’). Amongst other criteria, investee companies should not fall foul of the ‘Do No Significant Harm’ principle, by ensuring they do not negatively impact any social or environmental causes, even while contributing positively towards another.
Impact investors will also use ESG analysis and sustainability considerations in the investment process. However, the key difference is the directing of capital exclusively towards companies or projects providing intentional, measurable solutions to the world’s most pressing social and environmental challenges, such as climate change, better healthcare or inequality.
With a variety of investment approaches, and at times subtle differences between how these are implemented across strategies and companies, a key challenge for asset managers is to ensure their range of products cater to the diverse requirements and expectations of their client base.
What about exclusions?
In particular, clients may have strong views on which sectors or activities they feel comfortable investing in. For example, one client may be happy to invest in energy companies that are in the process of transitioning from fossil fuels to renewables, while others would not. Similarly, some clients may be happy for asset managers to select investments from all sectors, on the condition that they apply minimum overall scores or thresholds on ESG issues. Again, with such nuances between approaches, it is key for asset managers to understand clients’ requirements and offer the appropriate products.
The data challenge
Any responsible investment approach is only as effective as the data that informs it. And yet, with differing frameworks and a general reliance on company reporting, the evolving field of ESG and sustainability data poses challenges for investors. To overcome this, some asset managers will be content to rely solely on ESG data and scores from external providers and use these as a basis for their investment decisions.
As active investors, at M&G we carry out fundamental in-house research to inform our range of products, whether they are impact funds, sustainability funds or funds without a sustainable mandate that solely employ ESG considerations as part of the risk management framework.
M&G is an investor with a long pedigree of fundamental research capabilities. So, while we take account of external provider research, and utilise it for purposes such as monitoring for potential breaches of the United Nations Global Compact, this is supplemental to our own in-house research, both from our investment teams and in-house ESG research team. This allows us to have confidence in research outcomes, and to better understand the companies we invest in and the industries in which they operate, giving us a clearer picture of the related risks and opportunities. Furthermore, by conducting research in-house, we are better able to evidence our decision-making process, providing greater transparency for clients and other stakeholders.
Monitoring and reporting is essential
Asset managers must carry out ongoing monitoring of their products with regards to ESG or sustainability requirements, and report on this. The frequency, type and granularity of reporting will be set out in the pre-contractual documents seen by clients before they invest. In Europe, this reporting is now prescribed under the EU’s Sustainable Financial Disclosure Regulation (SFDR) framework.
For example, a fund utilising ESG integration as an extension of its risk management framework may have limited additional reporting obligations. Conversely, an impact equity fund may produce an annual impact report, which identifies key impact indicators for every holding (a measure chosen to assess the company’s positive impact) and reports the annual progress for these indicators.
Furthermore, asset managers must stay abreast of any incoming regulatory requirements when it comes to reporting. For example, in Europe the reporting of Principal Adverse Impact Indicators (PAIIs) under the SFDR requirements.
Kelly Hebert, Global Head of Sustainability Development, M&G Investments