Fund managers have largely succeeded in implementing ESG principles into investment and governance processes
But the picture is very different for assets owners, who in this respect appear less mature than the investment management community.
We undertook research analysing 45 of the largest UK asset owners with a combined assets under management of £770bn. We assessed ESG indicators such as transparency of reporting, outward communications, investment approach, use of technology, direct ESG resources and governance activities.
We combined this data to generate an overall ESG maturity ranking of 1-5, where ‘1’ reflects firms being less mature in executing and / or communicating their ESG agenda; a ‘3’ reflects more active engagement or dedicated ESG resources; and ‘5’ reflects an active ESG management approach. While there are examples of asset owners providing leadership around ESG, they are currently in a distinct minority.
We found that:
- Asset owners will have to enhance their ESG governance model maturity to meet upcoming regulations such as the stewardship code. The average ESG maturity score for the 45 asset owners we analysed was 1.8 out of 5.
- Smaller asset owners are far less ESG mature than their larger counterparts. There is a real difference between asset owners with £20bn and under to invest and those firms with larger investments. While this may reflect the availability of greater resources to dedicate to ESG, it may also reflect a perception that ESG investing is still viewed as a cost, rather than an opportunity.
- There are no published communications between asset owners and their members / investors. Consequently, it is difficult to see how the requirements of scheme investors are being reflected in fund structuring.
- Only four firms were awarded an ESG maturity score over 3 – representing just 9 percent of the group.
- Just one third of asset owners have dedicated ESG governance professionals. Of the 45 UK asset owners we analysed, only a minority dedicate resources to ESG governance. We expect this will change in the short term, as regulation and customer expectations trigger a refresh in asset owners’ approach to governance, requiring them to do more to demonstrate their commitment and track record on ESG issues.
- Asset owners have yet to sign up to Task Force on Climate-related Financial Disclosures (TCFD). Within our sample group, more than half have signed up to UN’s Principles for Responsible Investment, while a minority are supporters of the Taskforce on Climate-related Financial Disclosures (11). Just nine have signed up to both.
Our analysis suggests that in the UK most asset owners will have to transform how they govern ESG issues, and as a result will become much more prescriptive in their expectations of fund managers. Fund managers have been able to integrate ESG into their investment processes while it has been to date niche and relatively easy to manage – but going forward, there is work to be done on both the asset owner and fund manager side.
The advent of ESG integration alongside changing customer and investor expectations increases the scope of the task exponentially. To manage huge numbers of data, sources and technologies, fund managers will face significant challenges when building propriety rating systems and downstream governance and reporting.
Alpha lies in the data
Firms will need to leverage a range of unstructured, alternative and existing data sources and deploy new technologies to manage these challenges. We expect firms to make more complex investments going forward and as a result will need to support alternative data. Such alternative data might include Google Earth for deforestation purposes, email receipts, footfall or web browsing, for instance.
Despite the challenge, firms are beginning to agree upon and build propriety models. To construct a propriety ESG ratings framework, managers need data – and lots of it. Data engineering and analytics can be used to enrich data and exclude stocks that do not have the appropriate profile. However, each manager will need to create their own assessment criteria process for each stock that is to be analysed, reviewed or monitored.
Logistics dictate that human ESG analysts cannot manage an integrated ESG investment process as well as monitoring governance and reporting activities. The trick here will be to commoditise processes – with thousands of lines of stock to cover, automation is essential.
Firms won’t necessarily have to build everything from scratch. Many already have ESG investment processes, compliance monitoring systems and reporting frameworks. The digital revolution brings significant opportunities to complement ESG analysis and investment, reaching more investors and providing more reporting and tooling in consumable and user-friendly ways.
Richard Lewis (pictured) is partner and UK head of wealth & asset management and Charles Sincock is ESG lead at Capco