ESG ratings and integration
Other approaches are directly rooted in the investment process. Some 52% of survey respondents said that firms with high or improving ESG scores are an important part of their strategy. Of itself, this won’t surprise managers, but it does illustrate how ESG ratings are becoming an embedded factor in wider decision-making.
Where pension plans were seeing improving ESG scores, this could in turn signal the potential for high alpha.
Another aspect involves the integration of ESG risk and opportunities into the investment process, in such a way that it underpins strategic asset allocation. Nearly half of the respondents (49%) highlighted this as a major aspect of their wider approach.
Negative screening was also highlighted, or in other words the exclusion of companies engaged in harmful activities like pollution, poor work relations or lax business governance. This approach may have to evolve or at least navigate through the patchwork of pro- and anti-ESG legislation in the U.S, where some states, such as Texas, are introducing laws to ensure ESG ratings are not used punitively in investment decisions against firms.
Impact investing
A final method involves impact investing, highlighted by just over a third (37%) of the survey respondents as key to their wider investing strategy.
In effect, this targets a triple bottom line: robust financial, social, and environmental performance. It is defined by three pioneering concepts - materiality, intentionality, and additionality.
Materiality assesses whether a sustainability factor is material to a company’s business proposition and provides opportunities for enabling change. Intentionality appraises whether it intends to pursue impact-related goals as a result. Additionality assesses the extent to which desirable outcomes would not have occurred but for that investment.
The primary sources of additionality are the application of technologies or innovative business models, or meeting the needs of underserved populations, or transforming unsustainable business models into green ones.
Deeply embedded values
Along with prudent stewardship of precise ESG goals, the various approaches involved need to have ESG values embedded in the corporate DNA of asset managers.
Business leaders have long been reminded by regulators to ‘set the tone at the top’ by linking executive compensation with ESG targets and ensuring that stewardship reports provide narrative disclosures.
Whichever approach is taken, regulators, governments, activist shareholders, and campaign groups are putting more pressure on boards to see both concrete examples on the ground and meaningful numbers on ESG progress. Increasingly, the ability to provide evidence that ESG elements are fused into objectives, and that investees are held to account on sustainability pronouncements, is being tested.
ESG investing is about creating businesses of enduring value for four key stakeholder groups: shareholders, employees, customers, and the wider society. Collaboration and partnerships will be critical to delivering this promise. Asset managers will need help to access reliable, independent, qualitative, and quantitative data on ESG performance relative to objectives.
As the survey findings show, a laser-sharp focus on these areas will be key for managers of private equity and private debt, as ESG investing morphs into fundamental investing.
The report includes further survey results on current ESG allocations, mini case studies of pension plans’ experiences of ESG investing so far, and conclusions on how ESG investment decisions are shifting.
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