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Anatomy of a bona fide ESG fund
MANY fund management companies have caught on to the responsible investing trend. Fund managers are capitalising on this demand by launching new products or re-branding existing ones. There is a whole gamut of responsible investing products today from those that integrate environmental, social and governance (ESG) factors to those that promote positive impact to society.
How can one distinguish between a company which is committed to responsible investments, and another which is greenwashing (marketing their dubious ESG efforts as bona fide attempts in a bid to attract investors wanting to make a difference)? Admittedly, it is not easy. Almost every large fund management company is a signatory to the United Nations Principles for Responsible Investments (UNPRI). Almost every chief investment officer is talking about the need to integrate ESG factors into the investment processes, touting greater risk-adjusted returns if ESG were to be used in conjunction with traditional investment analysis.
In the course of my work, I have talked to quite a few representatives of ESG-compliant fund management companies. Through conversations with them, I have realised that there are characteristics that can help distinguish a company with strong commitment to responsible investments from a greenwasher.
Ability to explain the ESG investment process
Being a signatory to UNPRI or any equivalent responsible investing body demonstrates that a company is willing to commit a substantial portion of its assets under management to adhere to responsible investing processes. It is a good first step, but not sufficient. Almost any company can sign up without being a responsible investing firm by paying the annual fee and making a public commitment to do so. In fact, a company can plausibly use the signatory status without implementing the responsible investing processes for a period of two years, after which the UNPRI team will revoke its signatory status. And thus, the company may get away with attracting millions of investment dollars using the UNPRI signatory brand without results on the ESG front.
Therefore, for the UNPRI signatory brand to carry some weight in investor's decision-making process, the company should have been a signatory to the UNPRI for at least three years, demonstrating that it has gone through at least one full assessment from UNPRI. There is an annual assessment report comparing companies against their peer group, and this can usually be obtained by investors with access to the company's head of investor relations. The best in-class companies would be able to obtain a grading of "A+" on the UNPRI assessment report, handily beating its peers.
Moreover, a bona fide responsible investing company should be able to communicate the ESG integration process incorporated into its funds. The company can easily provide several case studies to clients. It would also be able to substantiate its use of ESG factors or scores, and how the actions of an investee company's management team have resulted in them making a decision to invest in or divest from the company. The greenwasher on the other hand would typically use generic language on ESG factors and scores, or claim that its process is "proprietary" so that it can get away with not having to explain its lack of effort on the responsible investment process.
A real responsible investing company practices stewardship
Companies with a commitment to responsible investments know that they have a fiduciary duty not only to their clients, but to society as well. They know that they must not harm their clients, such as overcharging them on fees. They also have to be a responsible corporate citizen. Corporate social responsibility (such as nudging staff to do regular meaningful charity work) is one aspect of it, but arguably the biggest impact that a fund management company can make is the area of active ownership, such as by exercising proxy votes. These companies have full teams of analysts and/or can engage proxy voting advisers to help them understand the resolutions of companies in their portfolios with regard to responsible investing principles.
Because proxy voting is so integral to stewardship, the responsible investing company would be again able to articulate through case studies on how it voted "for" or "against" management's proposals on ESG relevant matters. Fund management companies should also be able to provide detailed voting statistics of all ESG relevant resolutions that they have voted on.
Nevertheless, the best companies take it one step further. They collaborate with management and other investors to drive positive change in the company, such as working with investee company's management on key performance indicators to transition the company towards one with lower ESG risks. The greenwasher on the other hand is a passive shareholder, and does not bother with employing sufficient resources for proxy voting or other stewardship initiatives. It is hard to phantom a large fund management company, with billions of dollars of assets under management and perhaps only a skeletal team of ESG analysts, being that serious about ESG.
The right culture at the fund management company
A company that commits to responsible investments knows that the same high standards that they apply to their investee companies should be employed to themselves as well; they have to walk the talk.
At the minimum, they should embrace human resources policies to encourage a conducive environment for their employees. Such policies could include anti-harassment, pay equality and diversity policies.
And while no one except insiders would be able to determine if the company is merely paying lip service to incorporating ESG policies internally, it can be inferred that companies may not be up to mark when corporate scandals emerge. For example, the US-based Washington Post newspaper published an article in 2017 exposing a sexual harassment scandal at Fidelity Investments. One would naturally question if the company had anti-harassment policies at that time. If they did, were they routinely adhered to? Or more importantly, did the culture of the company encourage the desired behaviour?
On top of managing reputational risks, exemplary companies have senior executives who lead by example, articulating the importance of investing responsibly so that the culture permeates the company.
For example, Larry Fink, the CEO of BlackRock, has publicly communicated the company's focus on climate risk and promoted a number of initiatives such as exiting investments in thermal coal to arrest global warming. In other companies, senior executives have set up budgets in such a way to incentivise employees and investment professionals to promote recycling practices at their own companies.
If a company implements responsible investing processes, practises admirable stewardship, and has a culture of promoting responsible investing practices, it would have rightfully earned the status of a real responsible investment company. We should seriously consider supporting such companies with our investment dollars. After all, these are the very exemplary examples of ESG-compliant companies that make a positive impact to the world while generating investment returns for investors like us.
- Dexter Tiah, CFA, is an ESG specialist at Singapore-based Tsao Family Office and a certified financial risk manager