A lot of discussion of ESG comes from multiple perspectives - each as interesting as the other. What is to be said from the wealth manager's side of things? Andrew Summers, Head of Fund Research for Investec Wealth & Investment explores a new framework designed to measure ESG from the wealth manager's point of view.
Most of us attending this conference will be aware that ESG or SRI investing is a fundamental change in our industry. Historically wealth managers have typically offered clients the chance to “be a good person” and accept lower returns or “be a bad person” and benefit from higher returns.
An increasing body of evidence is suggesting that perhaps this awful choice is not necessary. Could it be that a proper ESG or SRI approach can maximise investment returns whilst at the same time doing good for society?
Do you really know if your ESG is good ESG?
After all, few of our private client have many specific requirements when it comes to investing ethically, socially or responsibility. But most, if asked, as we now have to do thanks to recent regulation, will say they want their investments run in a socially responsible way. But they generally don’t quite know what they mean by that and probably feel like it’s the right answer to give.
At Investec Wealth & Investment we have a well established proprietary qualitative framework for assessing active fund managers. It deliberately avoids an assessment of past performance.
We can do so confident in the knowledge that if our qualitative assessment is right, future performance (which is what we care about) should come.
This is supportive of an ESG element to our process. The data to measure the impact of ESG on investment returns is nascent and evolving. Whilst we recognise the academic and intuitive appeal of an ESG element, the empirical evidence is, on the whole, a work in progress.
The framework in detail
How should ESG considerations influence us at each stage of our qualitative process? Our framework is APPROVE: assets under management, philosophy, process, risk management, organisationally sound, value for money and exceptional talent. Let’s take each in turn.
The scale of the assets managed must be compatible with the investment objective given that excessive assets under management or taking in too much money too quickly are demonstrably bad for relative performance.
From an ESG perspective the substantial growth in assets managed under ESG mandates is a big challenge for these asset managers. Depending on the degree to which an ESG approach limits an investment universe or flows have elevated valuations, an asset manager must amply prove that they can manage the wall of money that is or may come their way.
"Could it be that a proper ESG or SRI approach can maximise investment returns whilst at the same time doing good for society?"
The investment philosophy must be intuitively appealing and able to deliver our required investment outcome. Further, the investment team must clearly articulate and demonstrate the efficacy of their investment philosophy.
Any fund manager who claims to have an ESG element to their investment process must be able to clearly articulate why their particular brand of ESG inclusion will lead to superior investment outcomes.
This will typically mean better relative performance, but it could also mean lower risk (however measured). The efficacy of their approach may well be difficult to show given ESG factor returns have not been demonstrable de-coupled from quality or low volatility factor returns.
Any fund with an ESG element must have it clearly incorporated into their process. How and when the ESG element is incorporated and the relative merits of their approach must be communicated and systematically proven without recourse to the “analysis by annecdoate” so favoured by fund managers.
Risks must be appropriately managed. UCITS vehicles are required to have sensible portfolio construction and risk management in place. However, for ESG considerations additional questions might include: factor, industry or style biases; valuation risk; liquidity risk. To the extent that an ESG approach incorporates new additional risk factors into security analysis, the asset manager must demonstrate these risks are appropriately managed.
"Any fund manager who claims to have an ESG element to their investment process must be able to clearly articulate why their particular brand of ESG inclusion will lead to superior investment outcomes."
We believe that companies that are organisationally sound provide the best environment for investment excellence to thrive. An asset management company that invests money in accordance with certain ESG criteria should themselves conform to the standards they expect of the companies they invest in. What better way to demonstrate they believe that ESG factors positively impact financial returns?
Value for money is essential in fund investing. Incorporating ESG factors cannot be an excuse for trying to swim against the inexorable tide in favour of lower costs. Having said that, there is a reason that we refer to value for money rather than costs (other than the “v” helps our APPROVE acronym!). value for money does not equal cost. Asset managers who can demonstrate that their ESG approach represents good value for money will be best placed.
Finally, we insist that all investment individuals should demonstrate peer leading investment skill. Exceptional talent is the first pre-requisite of achieving and investment objective. Teams who have invested with more than an eye to ESG considerations for a long time, not just since it has become fashionable, are most likely to deliver a value additive ESG approach
Andrew Summers will be speaking at FundForum Global ESG and Impact, 12 - 13 November, 2019, at The Amsterdam Marriott hotel. He will be speaking on a special workshop on how to see through greenwashing and discover what true ESG looks like.