The ESG 1-2-3 test

Right now, the investment industry feels awash with ESG — environmental, social and governance — messaging, products and services. But how can investors distinguish between asset managers with a truly integrated ESG approach and those with only limited capabilities?

Cutting through the noise

In Europe alone, sustainable fund flows hit about €55 billion (bn) during the second quarter of 2020. That was more than double the close-to €20bn they reached during the first quarter of 2019, according to Morningstar.1

Riding this wave, there are very few asset managers that don’t talk about ESG integration in their investment process. But knowing who is walking the walk and talking the talk can be an arduous task.

Many investment firms have teams of ESG specialists who produce reams of research — an asset that they’re only too happy to tout. Yet investors have no guarantee that any of this analysis feeds into the decisions their fund managers take.

We believe there are three tests that can reveal a lot about an asset manager’s ESG philosophy and working practices. Asking three simple questions can cut through the noise and help find those firms integrating ESG considerations into every step of their investment process.

Asking three simple questions, can cut through the noise and help find those firms integrating ESG considerations into every step of their investment process.

Test 1 – Think long term

The first test is to question whether an asset manager has set their sights on the long term.

In recent years, we’ve witnessed heightened volatility in the markets arising from U.S.-China trade tensions, Brexit and now the Covid-19 crisis. In this environment, many investors have succumbed to the temptation of making short-term plays in the hope of a quick profit. This demonstrates the potential for short-term factors like market sentiment and the chatter surrounding quarterly trading figures to sway investment decisions.

However, at Aberdeen Standard Investments (ASI), we argue that short-term considerations do not form part of a fully integrated ESG approach. We’re not looking for growth at any cost. That’s because our focus is on sustainable growth that’s not cyclically driven, but backed by long-term structural factors.

At its heart, a fully integrated ESG approach should have a three-to-five-year horizon. And it should focus squarely on company strategy, which is what ultimately drives fundamental value. If an asset manager is more interested in what lies just around the corner, it’s unlikely that they’re prioritizing ESG factors.

This is important because focusing on ESG issues from a company perspective is a major driver of long-term sustainability — as well as long-term value. Companies that set ambitious goals, such as those involving the environment and social wellbeing, tend to be more resilient to unforeseen events. That risk-mitigation element helps explain why many ESG-related funds have outperformed during the pandemic.

Test 2 – Closer ties

The second test of true ESG integration is to assess how closely involved the asset manager is in the engagement process with investee companies.

Different departments and teams will often undertake much of an asset manager’s engagement with companies. But unless the fund manager directly responsible for the portfolio plays a leading role in that engagement, it probably won’t really inform decision-making.

Engaging with companies is an essential ingredient of fully integrating ESG considerations into the investment process. And, as ESG investing has become more sophisticated, engagement has also become even more important. It's no longer enough to simply exclude a business practice, for example. To do a responsible job, you need resources to understand the issues and to identify when changes take place in a company.

At ASI, we meet at least twice a year with the companies in which we invest to discuss ESG-related and other themes. We also engage with these same companies through our ESG specialists. This is an additional point of contact that feeds back into company-specific research, as well as broader thematic analysis.

Test 3 – Turning research into practice

And now to the third and final test of an asset manager’s ESG integration. Question whether the insights that come from its research are driving investment decision-making and ask for tangible examples. Can a fund manager point to investments they have — or haven’t — made, and demonstrate how the firm’s research drove those decisions? If the answer is no, chances are that all the ESG analysis they’re producing is ultimately failing to drive value for its clients.

Final thoughts …

In today's market, there’s no shortage of asset managers claiming to offer their clients ESG-focused investing expertise. The question is, which of them can pass the three tests?

To find out more about our responsible investing credentials, visit our responsible investing site.

 Morningstar, "Sustainable fund flows hit record in Q2," August 4, 2020. 




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