A version of this article was originally posted on the Business Times and has been reproduced with the author’s permission; you can read the original article here
Would you want to make a positive contribution to the environment, for the benefit of all, and generate investment returns at the same time? If this sounds like wishful thinking to you, I would respectfully disagree - it is entirely possible to do so today.
Many fund management companies have caught on to the responsible investing trend brought about by the current generation of millennials that, among others, increasingly want to make a difference, and are able to do so by voting with their wallets. Companies are capitalizing 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 you then tell which firm is really committed to responsible investments, and which firm 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 has signed up as 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 these ESG-compliant fund management companies. Through conversations with them, I have realized that there are characteristics that can help distinguish a firm with strong commitment to responsible investments from a greenwasher.
Ability to explain the ESG investment process
Being a signatory to the United Nations Principles for Responsible Investments (UNPRI) or any equivalent responsible investing body demonstrates that a firm 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 firm can sign up to be a signatory without being a responsible investing firm, just by paying the annual fee and making a public commitment to do so. In fact, a firm is allowed to 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 firm can get away with attracting millions of investment dollars using the UNPRI signatory brand. Therefore, for the UNPRI signatory brand to carry some weight in investor’s decision-making process, the firm 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 firms to their peer group, and this can usually be obtained by investors with access to the firm’s Head of Investor Relations. The best in-class firms would be able to get a grading of “A+” on the UNPRI assessment report, handily beating its peers.
Moreover, a bona fide responsible investing firm should be able to communicate the ESG integration process incorporated into their funds. The firm can easily provide several case studies to clients. They would also be able to substantiate their 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 about ESG factors and scores, or claim that their process is “proprietary” so that they can get away with not having to explain their lack of responsible investment process.
A real responsible investing firm practices stewardship
Firms 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 active ownership, such as by exercising its proxy votes. These firms have full teams of analysts and/or can engage proxy voting advisors to help them understand the resolutions of companies in their portfolios with regards to responsible investing principles. Because proxy voting is so integral to stewardship, the responsible investing firm would be again able to articulate through case studies on how they have voted “for” or “against” management’s proposals with regards to ESG relevant matters. Fund management firms should also be able to provide detailed voting statistics of all ESG relevant resolutions that they have voted on. Nevertheless, the best firms 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 KPIs to transition the firm 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 firm
A firm 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 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 at the firm. And while no one except insiders would be able to determine if the firm is merely paying lip service to incorporating ESG policies internally, it can be inferred that firms may not be up to mark when corporate scandals emerge. For example, the US-based Washington Post published a news article in 2017 exposing a sexual harassment scandal at Fidelity Investments. One would naturally question if the firm had at that time anti-harassment policies. If they did so, were they routinely adhered to? Or more importantly, did the culture of the firm encourage the desired behaviour?
On top of managing reputational risks, exemplary firms have senior executives leading by example, articulating the importance of investing responsibly so that the culture permeates the firm. For example, Larry Fink, the CEO of Blackrock, has publicly communicated the firm’s focus on climate risk and promoted a number of initiatives such as exiting investments in thermal coal to global warming. In other firms, senior executives have set up a budget in such a way to incentivise employees and investment professionals to promote positive behaviour such as recycling practices at their own firms.
If a firm implements the responsible investing processes, practices admirable stewardship, and has a culture of promoting responsible investing practices, they would have rightfully earned the status of a real responsible investment firm. We should seriously consider supporting them with our investment dollars. After all, these are the very exemplary examples of ESG-compliant firms that make a positive impact to the world while generating investment returns for investors like us.