On 27th October, Saurabh Kumar participated in an insightful panel discussion on the need for improved fund governance and transparency within the ESG investment landscape in 2021 and beyond.
The webinar had a wide range of participants representing various segments of the buy-side ecosystem. Rachel Alembakis from FS Sustainability moderated the session; other panel members were Justin Kew from Carmignac Risk Managers, Brendon Baker from MSCI and Will Keuper from MackeyRMS.
Here are five key takeaways from the panel discussion:
- Events of 2020 have accelerated the demand for ESG: A majority of ESG funds have outperformed the broader markets. The ESG focus has gone deeper with climate scenario analysis and climate-VaR models. On the other side, many firms have also turned to greenwashing in order to achieve their Sustainable Development Goals (SDGs) and command premium valuation.
- ESG rating providers are under the spotlight: There is a tremendous pressure on asset managers to tilt portfolios in favour of highly rated ESG companies in spite of the fact that unlike credit ratings, correlations are much lower for ESG scores calculated for the same issuer by different ESG data vendors. There are two schools of thought on ESG ratings. One suggests that ESG ratings will go through the same journey as credit ratings with increased vendor consolidation and consensus in reporting standards, which would translate into stronger rating correlations in the long run. The other camp considers ESG ratings as another form of sell-side research which are intended to offer facts embedded with opinions. However, both camps are pleased with the way these vendors have navigated the size bias in their scoring models this year.
- More active managers are pursuing an integrated approach: Active managers tend to look deeper under the hood on ESG scores. They spend a significant amount of time in understanding the company’s purpose and their commitment to achieving that purpose. What that means is knowing what products and services they are looking to produce and how would that add value to society in general. The other aspect is to analyse how did they get there. There is a famous American electric car manufacturer. It has a cult-like following in the automotive industry with its cutting-edge technology and fresh design appeal. However, on the ESG scale, it is considered a high-risk company. The way they treat their employees and supply chain is not great, and their governance is always under scrutiny. That is why Portfolio Managers with active mandates tend to do more homework on research and try to overlay their proprietary investment process on top of vendor-provided ESG datasets. Without these additional processes embedded into their ESG analysis, a fund built solely on ratings is going to look and feel like a passive product, and it should be priced accordingly.
- There is a need to uplift ESG Data Management capabilities: Data is the lifeblood of ESG investing. There is so much data being published in the ESG space, both publicly, and through one-on-one interactions with management teams, that it has become imperative to have a system and a governance process to centralise the storage of vast quantities of ESG information into a book-of-record framework.
Being able to do that efficiently begins to touch on the growing need for improved investment governance for ESG-focused portfolios. In fact, this is already expanding into an incredibly important topic, particularly in Australia with fund of funds, with APRA to undertake a rigorous review of investment governance next year with the SPS 530 and SPG 530 frameworks. With these two initiatives, it will no longer be sufficient for incumbent fund of fund managers to stick to a high-handed approach and claim that they outsource all key investment decision making to external managers. These asset allocators will need to show due diligence maturity in their manager selection and monitoring process, demonstrate that they have had meetings with their fund managers and had conversations around ESG and active ownership, and maintain documentary evidence.
This, again translates into a data management puzzle, and that is the reason, having a robust data management discipline for ESG portfolios has swiftly moved from being a nice-to-have to a must-have capability, both in terms of systems and processes. Both asset managers and asset owners cannot simply afford to store data in emails, excel spreadsheets and network drive anymore. They will need a dedicated Research Management Solution (RMS) or at least some sort of a data warehouse to absorb and aggregate ESG market data from multiple sources. This will enable ESG data to be referenced on-demand for further analysis and integrated with core Investment Data models for various reporting requirements.
- The future-state of ESG investment landscape looks both promising and interesting at the same time: With a stellar out-performance during the COVID-19 season, the ESG theme has passed a critical test of time globally. ESG funds should continue to receive strong in-flows from investors at the cost of traditional non-ESG strategies. Buy-side firms will also accelerate the exercise of active ownership as part of their ESG decision making process. In Australia, the leading super funds have already pledged to achieve net-zero carbon emissions in their investment portfolios by 2050.
The divergence in regulation between the USA & the rest of the world regarding sustainable investing may continue to expand in 2021. This year, the Department of Labor (DOL) in the United States proposed a rule for private pension plans governed by the Employee Retirement Income Security Act (ERISA) stating that private employer-sponsored retirement plans are not for furthering social goals or policy objectives but rather to provide for the retirement security of workers. Later they came up with another rule that would require these plans to cast shareholder votes only on issues that have an economic effect on a retirement plan, implying they may not vote on ESG-related issues unless they have a measurable financial impact. In contrast, the European Commission has proposed an amendment to MiFID II rules that would mandate that investment firms consider the ESG preferences of their retail clients when providing investment advice. While in Asia, the regulators are mounting pressure on firms for more standardised, transparent, and meaningful ESG disclosures. Despite the disparity in the regulatory landscape, ESG funds will continue to thrive in the next decade with the help of strong client demand.