Under the microscope
16 February 2016
As asset managers strive to become more transparent, service providers might do well to ensure they’re tailored to new social and eco-friendly demands
Image: Shutterstock
Through everything from regulatory clampdowns to public scrutiny, the financial industry is undeniably being held increasingly to account. Simultaneously, corporate social responsibility is making the transition from buzzword to reality, and it’s about time that service providers sit up and start to take notice.
While different sectors of the industry view their responsibilities from different angles, it is becoming clear that although monetary gains are still at the centre of any institution, things are getting just a little more complicated than that.
Simon Howard, CEO of the UK Sustainable Investment and Finance Association (UKSIF), says: “The overarching element is the recognition that factors beyond the purely financial will drive the returns, the risks, and the long-term robustness of investments.”
David Harris, head of environment, social and governance (ESG) at FTSE Russell, is responsible for the index provider’s ESG products, including the FTSE4Good, which measures the performance of companies demonstrating strong ESG practices, benchmarking their performances and tracking progress in these areas.
According to Harris, there are two sides to measuring sustainability performance. The first relates to ESG and looking at a company’s operations—how well governed and operationally efficient a company is, and how its direct activities affect the environment, its staff, local communities or suppliers.
The other side focuses on what a company manufactures, specifically relating to products and services produced, and how a company contributes towards the transition to a low carbon economy (LCE).
Although these factors are often confused, Harris stresses: “We define those areas very clearly and very separately.”
FTSE Russell’s ratings score companies on their ESG performance, and the businesses that reach above a certain threshold are included in the FTSE4Good indices. While a renewable energy manufacturer could produce 100 percent ‘green’ revenues, it may use unethical labour or have poor management of toxic pollutants in the manufacturing process. As a result, it would score poorly for ESG, despite its apparent low carbon contribution.
Equally, a mining company may not produce any ‘green’ revenues, but may score highly for ESG due to excellent governance, a strong relationship with its local community and careful environmental management around its mine site.
“It’s really up to clients as to how they want to use the ESG and LCE data,” says Harris. “We see some clients that are only interested in one aspect or the other, some that are interested in both and some looking for an overlap.”
Whatever clients are looking to gain from the index, interest is building, and investing in responsible issuers is becoming a more common priority.
“When we launched FTSE4Good in 2001 it was a pretty niche area. Over 15 years we have seen more sophistication in client understanding.”
“For a large proportion of our clients, this is now high on their agenda. They’re interested in getting access to the data to develop a better understanding of the important issues.”
However, for modern investors, responsibility goes further than the merit of the issuer. Broadridge’s proxy voting solution focuses on corporate governance, facilitating the transparency that shareholders require to properly consider and fulfil their voting obligations.
Patricia Rosch, president of international investor communication solutions at Broadridge, says: “Historically, the focus of responsible investing was on ensuring that holdings didn’t include companies that fell into certain categories such as arms companies, tobacco or alcohol producers, or companies with an obvious and direct environmental impact like mining or oil companies.”
“Today, we are seeing proactive socially responsible investment; investors want to hold companies with strong economic performance and socially acceptable processes, too.”
Paul Lee, head of corporate governance at Aberdeen Asset Management, takes a similar view. At Aberdeen, he says, the focus is on stewardship—acting as a responsible owner of the companies in which it invests on behalf of its clients.
Lee suggests that the very idea of responsible investing “can by some be understood narrowly, as being just a discussion on a handful of topics that are temporarily fashionable”.
As long-term buy-and-hold investors, Aberdeen strives to think and act like the asset owner. Lee says: “Owners stay involved with companies, have active dialogue across a range of issues that go to long-term value, and seek to ensure there is a clear chain of accountability, which helps to encourage all parties to generate value.”
More commonly, he says, end investors are looking for more clarity around what exactly their asset manager is doing, recognising “that it is a crucial way in which fund managers can protect and enhance value in their portfolios”.
Also drawing attention to long-term investment goals, Harris suggests interest is coming primarily from asset owners—the pension funds and sovereign wealth funds, which consider it part of a long-term investment agenda.
“Institutional investors are becoming more interested in long-term investment trends and strategies. They see responsible investment as a very relevant part of that discussion. Some asset owners are concerned that the culture of investment management is about returns over very short periods of time rather than the decades over which their liabilities fall.”
“ESG data is often considered to help with the marathon, but may be less useful for the sprint.”
The perception is that a company addressing its ESG and climate change responsibilities is generally well managed, and therefore likely to deliver more consistent returns in the long run. On top of this, with the general public becoming increasingly ethically aware, failing to prove an active approach to ESG could have disastrous effects on a firm’s reputation.
Harris says: “Some fund managers are actually starting to lose mandates because they can’t demonstrate to asset owners that they’re properly integrating environmental, social and governance considerations into the investment process.”
While Howard partially attributes the increased scrutiny from asset owners to further-reaching regulatory restraints, he also notes that by handling these issues with ease, fund managers can get ahead of the competition.
He says: “Asset owners want to know more about their assets. This reflects some legal developments, which are making the burden on pension trustees clearer, but also the reputational risk the owners are exposed to if their managers are doing things and they don’t know.”
“Answering and anticipating these questions gives the best fund managers a chance to build a better relationship with clients and to differentiate themselves.”
Equally, Lee highlights—and embraces—the challenge of handling such inquisitive clients, saying: “Many are asking more challenging questions about individual holdings. The accountability helps keep us on our toes.”
According to Rosch, solutions such as Broadridge’s ProxyDisclosure can help to address this accountability, by reporting which holdings are included in a fund and how the fund manager voted the proxy for each. While in some jurisdictions, such as the US, this is a regulatory requirement, even outside of any regulatory remit Broadridge has seen a demand for this service.
“Broadridge provides the tools to allow institutions not only to meet regulatory requirements, but also to demonstrate accountability to their underlying investors,” says Rosch. “Our tools support the increasing demand for greater transparency.”
“Institutions and pension funds take proxy voting very seriously. Voting gives them a voice to communicate with the issuer, to demonstrate support for management—or not—and that’s increasing in importance as part of strong governance practices.”
Another not-quite-regulatory catalyst that has led to improved data and transparency within fund management was, according to Harris, the emergence of the United Nations-backed principles for responsible investment (PRI). The principles surround the way investors integrate ESG factors into their processes, including issues around engagement and stewardship.
“A number of the large asset owners became members, and that then sent a signal to the asset managers that they needed to as well,” says Harris.
And signing up to the principles is not where it ends. There is a requirement for signatories to annually explain their investment and stewardship approaches, which are then made public.
“That creates ongoing momentum, and it can help different institutions learn from one another. This is still a growing area covering complex and varying issues, and I think most asset owners and asset managers would admit that it’s a learning process.”
It’s a significant change to investment culture, but the balance is shifting. According to Harris, seven of the 10 largest pension funds globally are now signed up to the PRI, making it “quite hard for the asset managers to resist”.
Regulation and reputation aside, there is also the simple fact that investors may want to create positive change. On the other hand, there is the more concrete fact that investors are always looking for returns on their investments. “People want to make money and make a difference,” says Howard, “which is possible with responsible investment funds.”
He says: “The market share of retail responsible investment funds is at a high. In the institutional market an increasing number of fund managers and asset owners are recognising that considering ESG issues mitigates various risks and can highlight opportunities.”
Howard also highlights the challenges that remain in what is still fairly unchartered territory. He says: “I think complexity is the big challenge. Responsible investment demands the assessment of issues such as stakeholder rights in various countries, difficult environmental issues such as nuclear power and genetically modified food, and questions on things like executive pay. None of these have easy answers and the approaches are still evolving.”
“There are many issues and no certain solutions. But at present doing something with a sensible adviser or fund manager is better than doing nothing.”
Lee also has concerns, suggesting that in some cases, the importance of perceived responsibility takes precedence over actually acting responsibly. He says: “There is a good deal of talk in this area, and much less genuine activity. I suspect that clients would find it hard to distinguish between those fund managers genuinely carrying out their role as good stewards of their investments, and those who only pay lip-service.”
But challenge breeds innovation, and if interest in investor responsibility continues to grow, there will come a time that fund managers can no longer afford to ignore it. Those who are ready to cater to the new needs of clients will be the ones that prosper.
Broadridge’s suite of proxy solutions is a step in this direction, bringing attention to transparency and improving governance.
Rosch says: “We provide solutions to help investors quickly and efficiently vote and report their proxies, so they can focus their time and attention on reviewing and researching companies to build better portfolios.”
Harris suggests that there has been an uptick in companies actively seeking to provide their ESG and carbon data, and taking steps to make sure that it’s positive data—something that he believes could have a significant impact.
“Indices like FTSE4Good really turn the market on its head,” he says. “We have very transparent ESG standards, and that creates a very visible threshold that it’s possible to engage companies on. If a company isn’t in that index, it encourages them to meet those standards in order to gain inclusion.”
With interest from market participants showing no signs of slowing, the implication is that service providers will have to start thinking about how they can keep up with, and cash in on, a growing trend. Howard concludes: “The key thing is to recognise that the market for responsible investment is growing fast and will continue to grow. It will place new demands on everyone in the value chain … If providers can cater to that they will have an advantage.”
While different sectors of the industry view their responsibilities from different angles, it is becoming clear that although monetary gains are still at the centre of any institution, things are getting just a little more complicated than that.
Simon Howard, CEO of the UK Sustainable Investment and Finance Association (UKSIF), says: “The overarching element is the recognition that factors beyond the purely financial will drive the returns, the risks, and the long-term robustness of investments.”
David Harris, head of environment, social and governance (ESG) at FTSE Russell, is responsible for the index provider’s ESG products, including the FTSE4Good, which measures the performance of companies demonstrating strong ESG practices, benchmarking their performances and tracking progress in these areas.
According to Harris, there are two sides to measuring sustainability performance. The first relates to ESG and looking at a company’s operations—how well governed and operationally efficient a company is, and how its direct activities affect the environment, its staff, local communities or suppliers.
The other side focuses on what a company manufactures, specifically relating to products and services produced, and how a company contributes towards the transition to a low carbon economy (LCE).
Although these factors are often confused, Harris stresses: “We define those areas very clearly and very separately.”
FTSE Russell’s ratings score companies on their ESG performance, and the businesses that reach above a certain threshold are included in the FTSE4Good indices. While a renewable energy manufacturer could produce 100 percent ‘green’ revenues, it may use unethical labour or have poor management of toxic pollutants in the manufacturing process. As a result, it would score poorly for ESG, despite its apparent low carbon contribution.
Equally, a mining company may not produce any ‘green’ revenues, but may score highly for ESG due to excellent governance, a strong relationship with its local community and careful environmental management around its mine site.
“It’s really up to clients as to how they want to use the ESG and LCE data,” says Harris. “We see some clients that are only interested in one aspect or the other, some that are interested in both and some looking for an overlap.”
Whatever clients are looking to gain from the index, interest is building, and investing in responsible issuers is becoming a more common priority.
“When we launched FTSE4Good in 2001 it was a pretty niche area. Over 15 years we have seen more sophistication in client understanding.”
“For a large proportion of our clients, this is now high on their agenda. They’re interested in getting access to the data to develop a better understanding of the important issues.”
However, for modern investors, responsibility goes further than the merit of the issuer. Broadridge’s proxy voting solution focuses on corporate governance, facilitating the transparency that shareholders require to properly consider and fulfil their voting obligations.
Patricia Rosch, president of international investor communication solutions at Broadridge, says: “Historically, the focus of responsible investing was on ensuring that holdings didn’t include companies that fell into certain categories such as arms companies, tobacco or alcohol producers, or companies with an obvious and direct environmental impact like mining or oil companies.”
“Today, we are seeing proactive socially responsible investment; investors want to hold companies with strong economic performance and socially acceptable processes, too.”
Paul Lee, head of corporate governance at Aberdeen Asset Management, takes a similar view. At Aberdeen, he says, the focus is on stewardship—acting as a responsible owner of the companies in which it invests on behalf of its clients.
Lee suggests that the very idea of responsible investing “can by some be understood narrowly, as being just a discussion on a handful of topics that are temporarily fashionable”.
As long-term buy-and-hold investors, Aberdeen strives to think and act like the asset owner. Lee says: “Owners stay involved with companies, have active dialogue across a range of issues that go to long-term value, and seek to ensure there is a clear chain of accountability, which helps to encourage all parties to generate value.”
More commonly, he says, end investors are looking for more clarity around what exactly their asset manager is doing, recognising “that it is a crucial way in which fund managers can protect and enhance value in their portfolios”.
Also drawing attention to long-term investment goals, Harris suggests interest is coming primarily from asset owners—the pension funds and sovereign wealth funds, which consider it part of a long-term investment agenda.
“Institutional investors are becoming more interested in long-term investment trends and strategies. They see responsible investment as a very relevant part of that discussion. Some asset owners are concerned that the culture of investment management is about returns over very short periods of time rather than the decades over which their liabilities fall.”
“ESG data is often considered to help with the marathon, but may be less useful for the sprint.”
The perception is that a company addressing its ESG and climate change responsibilities is generally well managed, and therefore likely to deliver more consistent returns in the long run. On top of this, with the general public becoming increasingly ethically aware, failing to prove an active approach to ESG could have disastrous effects on a firm’s reputation.
Harris says: “Some fund managers are actually starting to lose mandates because they can’t demonstrate to asset owners that they’re properly integrating environmental, social and governance considerations into the investment process.”
While Howard partially attributes the increased scrutiny from asset owners to further-reaching regulatory restraints, he also notes that by handling these issues with ease, fund managers can get ahead of the competition.
He says: “Asset owners want to know more about their assets. This reflects some legal developments, which are making the burden on pension trustees clearer, but also the reputational risk the owners are exposed to if their managers are doing things and they don’t know.”
“Answering and anticipating these questions gives the best fund managers a chance to build a better relationship with clients and to differentiate themselves.”
Equally, Lee highlights—and embraces—the challenge of handling such inquisitive clients, saying: “Many are asking more challenging questions about individual holdings. The accountability helps keep us on our toes.”
According to Rosch, solutions such as Broadridge’s ProxyDisclosure can help to address this accountability, by reporting which holdings are included in a fund and how the fund manager voted the proxy for each. While in some jurisdictions, such as the US, this is a regulatory requirement, even outside of any regulatory remit Broadridge has seen a demand for this service.
“Broadridge provides the tools to allow institutions not only to meet regulatory requirements, but also to demonstrate accountability to their underlying investors,” says Rosch. “Our tools support the increasing demand for greater transparency.”
“Institutions and pension funds take proxy voting very seriously. Voting gives them a voice to communicate with the issuer, to demonstrate support for management—or not—and that’s increasing in importance as part of strong governance practices.”
Another not-quite-regulatory catalyst that has led to improved data and transparency within fund management was, according to Harris, the emergence of the United Nations-backed principles for responsible investment (PRI). The principles surround the way investors integrate ESG factors into their processes, including issues around engagement and stewardship.
“A number of the large asset owners became members, and that then sent a signal to the asset managers that they needed to as well,” says Harris.
And signing up to the principles is not where it ends. There is a requirement for signatories to annually explain their investment and stewardship approaches, which are then made public.
“That creates ongoing momentum, and it can help different institutions learn from one another. This is still a growing area covering complex and varying issues, and I think most asset owners and asset managers would admit that it’s a learning process.”
It’s a significant change to investment culture, but the balance is shifting. According to Harris, seven of the 10 largest pension funds globally are now signed up to the PRI, making it “quite hard for the asset managers to resist”.
Regulation and reputation aside, there is also the simple fact that investors may want to create positive change. On the other hand, there is the more concrete fact that investors are always looking for returns on their investments. “People want to make money and make a difference,” says Howard, “which is possible with responsible investment funds.”
He says: “The market share of retail responsible investment funds is at a high. In the institutional market an increasing number of fund managers and asset owners are recognising that considering ESG issues mitigates various risks and can highlight opportunities.”
Howard also highlights the challenges that remain in what is still fairly unchartered territory. He says: “I think complexity is the big challenge. Responsible investment demands the assessment of issues such as stakeholder rights in various countries, difficult environmental issues such as nuclear power and genetically modified food, and questions on things like executive pay. None of these have easy answers and the approaches are still evolving.”
“There are many issues and no certain solutions. But at present doing something with a sensible adviser or fund manager is better than doing nothing.”
Lee also has concerns, suggesting that in some cases, the importance of perceived responsibility takes precedence over actually acting responsibly. He says: “There is a good deal of talk in this area, and much less genuine activity. I suspect that clients would find it hard to distinguish between those fund managers genuinely carrying out their role as good stewards of their investments, and those who only pay lip-service.”
But challenge breeds innovation, and if interest in investor responsibility continues to grow, there will come a time that fund managers can no longer afford to ignore it. Those who are ready to cater to the new needs of clients will be the ones that prosper.
Broadridge’s suite of proxy solutions is a step in this direction, bringing attention to transparency and improving governance.
Rosch says: “We provide solutions to help investors quickly and efficiently vote and report their proxies, so they can focus their time and attention on reviewing and researching companies to build better portfolios.”
Harris suggests that there has been an uptick in companies actively seeking to provide their ESG and carbon data, and taking steps to make sure that it’s positive data—something that he believes could have a significant impact.
“Indices like FTSE4Good really turn the market on its head,” he says. “We have very transparent ESG standards, and that creates a very visible threshold that it’s possible to engage companies on. If a company isn’t in that index, it encourages them to meet those standards in order to gain inclusion.”
With interest from market participants showing no signs of slowing, the implication is that service providers will have to start thinking about how they can keep up with, and cash in on, a growing trend. Howard concludes: “The key thing is to recognise that the market for responsible investment is growing fast and will continue to grow. It will place new demands on everyone in the value chain … If providers can cater to that they will have an advantage.”
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