Investors put new weight behind ESG mandates

Institutional investors have focused on ESG for many years, but the industry may be reaching a tipping point in terms of the specificity and sophistication of ESG mandates. Against a backdrop of increasingly hard to ignore climate risks and social unrest brought on by the COVID-19 pandemic, the death of George Floyd and the war in Ukraine, institutions are moving away from passive exclusion strategies and leveraging new data to engage with management teams, set specific goals and measure impact.

Indications of these shifts are already underway. Thomas Shingler, Summit, N.J.-based senior vice president and ESG practice leader at consultant Callan LLC, said investors may individually be at different places on their environmental, social and governance journey, but broadly nearly all of them are engaged in data gathering, thinking through best practices and/or working through how to implement investment approaches that are measurable and provide value.

“The goals of each investor are going to be unique, mandates are going to be different relative to the size and flexibility of a given plan,” Mr. Shingler said. “There are large public plans that have very large, very sophisticated investment programs. They can use their own investment staff or design a custom mandate. For small to medium plans, or ERISA plans, it’s going to be a different process. We also work with some investors that are religious organizations that are thinking about ESG from that perspective and are trying to align their portfolios accordingly.”

Money managers reported a total of $28.03 trillion in global assets managed under ESG principles as of Dec. 31, according to Pensions & Investments’ money managers survey, up 21.9% from the year before and up 415% from five years earlier. Worldwide ESG mandates totaled $3.59 trillion, up 22.7%.

According to data from Morningstar Inc., investors are pouring billions of dollars into ESG strategies even during periods of market stress when asset flows as a whole have declined. But how they expect that money to be put to work is changing. To differentiate in ESG now means being able to demonstrate not just positive financial performance but in-depth expertise on what the transition to a sustainable economy means and how that impacts portfolios on an ongoing basis.

The majority of ESG allocations are going into actively managed equities strategies, and climate funds are currently a big focus for investors as they work to align their investment portfolios to net-zero emissions goals, managers said. Aligning to net-zero at the portfolio level means investing only in companies that also have a net-zero goal or a plan to adopt a net-zero goal.

“Climate change has always been the pre-eminent issue with ESG investing,” said Berenice Lasfargues, New York-based sustainability integration lead at BNP Paribas Asset Management. “Within climate change, recently there is an increased focus on how to decarbonize portfolios through specific net-zero allocations. That is being supported by improvements in company ESG disclosures specifically related to carbon, which are mandated in certain jurisdictions.”

BNP Paribas Asset Management plans to launch a net-zero road map later this summer to help investors that are new to decarbonization navigate the process. The road map is based on the ESG metrics research Ms. Lasfargues and others are doing at BNP AM’s Sustainability Center, which launched in 2018. The Sustainability Center anchors BNP’s firmwide sustainability approach, which was overhauled in 2019 to accelerate its commitments to sustainable investment and create a model that could be used to meet investor mandates.

The approach includes four components: ESG integration, stewardship, exclusions and a forward-looking perspective. Each of the components has its own metrics so progress can be measured and reported to investors. All components are implemented firmwide and across all assets under management.

“When we began our sustainability overhaul, we asked our portfolio managers to go through an initial ESG validation process, basically asking them ‘How do you plan to integrate ESG?’” Ms. Lasfargues said. “We understood that ESG integration approaches can vary by strategy and asset classes; however we were also able to drive some top-down consistency with our firmwide public ESG integration guidelines.”

BNP Paribas Asset Management reported $518 billion in global assets managed under ESG principles as of Dec. 31, up 28.2% from the year before, according to P&I data. That included $95 billion in ESG mandates, up 28.9% from the end of 2020. BNP’s overall AUM was $611.7 billion as of Dec. 31, up 3.8%.

Improvements in data and reporting are also supporting actively managed quantitative strategies that are aligned to investor ESG goals.

In its response to P&I’s open-ended question on what differentiates its ESG strategy, HSBC Asset Management said it has created a specialist quant team that uses ESG data and research supplemented by fundamental analysis from its equity and credit teams to create a unique ESG approach. The manager’s ESG scoring methodology is backtested with all factors included in financial materiality tests. Portfolio, asset class and sector teams focus on portfolio weighting using those scores.

“Client objectives underpin how we integrate ESG investing into different portfolios and our ESG solutions are backed with data, examples, and clear transparent reporting,” the firm said in the survey.

HSBC had $629.3 billion in assets managed under ESG principles as of Dec. 31, up 9.6% for the year. ESG mandates totaled $29.7 billion, up from $12.2 billion the year before.

The desire for data-driven and goal-aligned strategies is also being pushed by investors in private equity funds. According to a recent report from management consultant Bain & Co., an “overwhelming majority” of private equity investors say they will walk away from a deal if it poses ESG concerns. Investors also want to see more ESG-related metrics and are including those requests in their mandates. Some 80% say they plan to increase the scope of such requests over the next three years. Nearly 70% also say they plan to increase ESG investment allocations and in-house ESG-related capabilities over that same period. More than 100 limited partner investors were surveyed.

With companies offering broader and deeper ESG reporting, and asset managers responding accordingly with more sophisticated strategies, new frontiers are opening up. Hannah Simons, London-based head of sustainability strategy for global asset manager Schroders PLC, said forward-looking investors are starting to focus on impact strategies, a move that could influence the direction of travel for other investors as they get farther along on their ESG journey.

Schroders recently updated its own ESG reporting to improve transparency and provide more information on potential impact. Ms. Simons noted that some of this has been driven by increased regulatory requirements throughout the European Union, U.K., and U.S., but a significant portion is also coming as a result of investor demand.

On the investment side, Schroders’ portfolio managers are also taking a closer look at positive inclusion factors within ESG strategies. Rather than simply excluding high emitters, for example, analysts are looking more closely at improvement plans, the success of engagement efforts with managers including proxy actions, and the societal impacts of a given company.

The Schroder ISF Global Climate Leaders range of funds puts some of this into practice by attempting to identify companies that are taking active leadership roles on climate and decarbonization. Climate leaders are companies that have ambitious targets to decarbonize consistent with achieving a 1.5-degree scenario or better under the Paris Agreement for climate change.

“What we’re seeing is that the bar is continuing to rise. What ESG integration means in practice continues to expand. And with that, there is a greater focus on impact,” Ms. Simons said. “The momentum is moving toward not just sustainability but how do we solve real problems. Investors are looking at the environmental and social problems we face today and saying how do you deploy capital to fix that? What is the role of the financial services industry? How can we measure that?”

Schroders reported $833.2 billion in AUM as of Dec. 31, all managed under ESG principles. That includes $10.8 billion in ESG mandates, more than double the $4.6 billion from a year earlier.