ESG’s influence on fund manager investment decisions
This article was produced in association with ELITE Connect. It was originally published on the ELITE Connect platform.
As ESG issues continue to feature on the investment agenda, there’s a growing trend of fund managers incorporating key topics into their analysis and valuation models through ESG integration. Indeed, with the Principles for Responsible Investment (PRI) initiative stating that ‘integrating ESG factors into analysis of listed equity investments is the most widespread responsible investment practice in the market today’, the trend looks set to stay – and can only grow in significance.
Commenting on trends in the Netherlands, Robert Klijn, ESG specialist at Fair Impact, observes that two of the country’s largest pension fund managers have been proactive in their ESG integration. ‘APG has an internal website that integrates ESG indicators and news provided by external data providers with voting and engagement records,’ he says. ‘In this way, views on companies are backed by qualitative analysis.
‘Similarly, PGGM has developed an ESG overlay for its passive equity investments where performance on ESG factors determines which bottom 10 percent of the companies are excluded, besides the legal and ethical exclusions. In addition to these two big pension funds, more and more medium-sized Dutch pension funds have started to dedicate extra resources to implement ESG factors in their investment process.’
Voicing agreement to the importance of ESG, Ben Yeoh, senior portfolio manager at RBC Global Asset Management, comments: ‘ESG investing has gone from being a tangential topic for investors to an increasingly important consideration in the decision-making process. Instead of approaching ESG as a distinct issue separate from financial health, we should really approach it as a non-traditional source of risk.’
And it’s this ‘non-traditional’ risk that can present a challenge to fund managers, Yeoh adds. ‘ESG issues largely lie outside formal reporting structures and, as a result, are often neglected in traditional financial analysis,’ he explains. ‘But being non-traditional doesn’t mean ESG factors matter any less as a potential source of risk. After all, few of us would want to be invested in a firm that loses the trust of its employees, suppliers or customers. A company with poor consideration of ESG issues will find itself at a disadvantage to competitors that give them more attention.’
These ‘risks’ also present strong opportunities, however. ‘ESG factors, along with other issues such as corporate culture and employee and customer engagement, are typically long-term intangible assets that can have a short-term financial cost, but will pay off handsomely over the longer term,’ Yeoh continues. ‘These intangible assets are hardly ever found in the reports and accounts. Information on them is hard to access, assimilate and conclude from. But they are nonetheless a very powerful predictor of long-term financial performance.’
Cécile Biccari, managing partner at Contrast Capital, agrees, observing that communication is key to success and fund managers need to make it clear to companies what their priorities are to allow them to respond accordingly. ‘Mainstream investors are becoming more sophisticated in the way they integrate ESG information in their investment processes,’ she says. ‘But they often fail to explain to companies what information matters most to them, how it relates to their broader financial analysis and how it impacts investment decisions.
‘It’s a two-way street, however: companies should also proactively identify those fund managers that are already systematically applying this integrated ESG approach and prioritize them in their outreach efforts. By engaging with them, companies can progressively build a core group of shareholders that are likely to invest for the long term.’