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ESG integration: how to monitor your external manager?

28-11-2014 | Insight While ESG integration seems high on the agenda of many asset owners, implementation remains a challenge when selecting and monitoring external managers. Cécile Churet, Sustainability Investing Client Specialist at RobecoSAM, researched the industry trends and concluded that there is still a long way to go.

Churet analyzed over 80 reports from PRI signatories on the implementation of sustainable investment approaches. Her analysis focused on manager selection, legal appointment and monitoring. The incorporation of sustainable investment criteria into manager searches is highly relevant because two-thirds of asset owners outsource at least 10% of their listed equity investments to external asset managers and a quarter use external asset managers for more than 50% of their listed equity. Churet discussed her preliminary findings with a group of 20 asset owners and investment consultants at a briefing event in London in June.

Preference for ESG integration
When asked which sustainability investing approach asset owners want their external asset managers to apply, 70% indicated ‘ESG integration’, compared with 50% for screening and 25% for thematic approaches. However, this preference implies two challenges, i.e. identifying asset managers that truly integrate ESG into their investment decisions, and ensuring these aspects are incorporated in mainstream asset manager searches - and are actually implemented as intended. Churet found that while a fair amount is being done at the manager selection stage, less is done in terms of monitoring and ongoing dialogue with asset managers once they are selected.

Formalization in mandates is lacking
A major challenge appears to be the appointment stage, as few SI-related aspects investigated at the selection stage are translated into formal contractual agreements. Only 6% of asset owners include reporting on portfolios’ SI characteristics in the contract clauses with their asset managers. Feedback from asset owners has been that part of the challenge of formalizing these requirements into legally binding agreements comes from legal advisers who are not convinced about ESG integration.

Is ESG integration truly evaluated?
Similarly, less than 40% use a sustainable investment criterion as a formal component of manager performance evaluation. Two-thirds of asset owners assess managers’ ESG incorporation strategies, but less than half actually assess the quality and coverage of the ESG research used by the asset managers, or meet with their investment staff to review their SI competences.

As asset managers become more sophisticated and consider ESG issues as part of their fundamental analysis, using different sources of data and feeding them into their valuation models and investment decisions, it will become more difficult to isolate the ESG component of the investment process.

A long way to go
In conclusion, while ESG integration seems high on the agenda of PRI signatories, implementation remains a challenge. What’s more, these findings represent the practices of the most committed and most advanced asset owners. For much of the pension fund industry, there is still a long way to go on sustainable investment.

Similar findings were observed across the whole PRI signatories’ base. To read more, please read the 2014 PRI Report on Progress

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