The process for evaluating an ESG manager is similar to the process an ESG fund manager uses when evaluating a company — here are a few preliminary steps asset owners should take when beginning the search for an investment manager that integrates ESG.
One size does not fit all when it comes to sustainable investing; just as there is no single path for a company to become “sustainable,” there is no set formula for investors looking to build a sustainable portfolio. One consistent factor, however, is that building a sustainable company requires a holistic approach, and so too does selecting investment managers that focus on sustainability.
Since each company’s path to sustainability is unique, the investment manager must evaluate each potential investment opportunity on its own merits, evaluating the environmental, social and governance (ESG) practices of each company within the context of the critical considerations that apply to sustainability within that industry.
The evaluation that goes into selecting an investment manager that effectively analyzes ESG factors is similar. The due diligence process requires an understanding of the investment philosophies and processes of the investment manager, and whether it is effectively integrating ESG factors into its investment decisions. Based on this initial assessment, the universe can be narrowed to a group of managers that qualify for further due diligence. Just as investment managers cannot evaluate a company without meeting its management team, effective due diligence requires meeting the investment team. Putting all those factors together, there are a few preliminary steps asset owners should take when beginning the search for an investment manager that integrates ESG.
1. Determine your goals
The asset owner should start by asking the question: “What are our goals?” These can include full ESG integration across all asset classes, a portfolio that aligns with a particular set of norms (e.g., the UN Sustainable Development Goals), or thematic investing that focuses on a particular ESG theme or screens out a sector (e.g., a fossil-fuel-free portfolio). Once the asset owner has established its goals, these can be incorporated into an investment policy statement and the universe of investment managers can be narrowed.
2. Do your research
The due diligence process for evaluating ESG investments requires a combination of background research, an understanding of the investment process, and face-to-face meetings with the investment manager to ensure the following:
that ESG factors are considered as part of the investment process;
that the manager understands how different factors are material to different industries and companies; and
that the process is time-tested.
The UN Principles of Responsible Investing features an extensive list of due diligence questions on its website, and emphasizes that different asset classes require a different set of questions. For example, due diligence for a real estate manager with a 10-year lock-up will be different than due diligence for a liquid fixed income manager investing in government securities. In a long-term real estate portfolio, the due diligence questions should include an understanding of the risk evaluation of rising sea levels in certain regions, for example. In a liquid fixed income investment, on the other hand, it may be important to understand how a green bond gets evaluated.
3. Ask the hard questions
Investors must ask questions to ensure that the asset manager they select doesn’t just advertise strong ESG integration, but that its processes do in fact consider and incorporate these factors in a material way. Firms are challenged by a lack of consistent disclosure by companies on ESG, and in some areas a lack of a universal definition over what constitutes good corporate behavior. Understanding how firms overcome these challenges is critical to selecting an asset manager.
To make sure the approach is genuine, it can help to ask a series of important questions:
Do you incorporate ESG analysis into your investment process; and if so, how?
Why do you include these factors?
How long have you incorporated sustainable or ESG factors into your investment process? How has the process evolved over time?
Do you use third-party services in your responsible investing approach, or your own analysis?
Do you measure the impact of ESG integration?
Do you engage with management or boards of investee companies on ESG issues? If so, how frequently?
What are your proxy voting guidelines? How do you ensure implementation?
Can you give us an example of where you have successfully engaged with a company on an ESG concern?
Assessing a firm’s ESG approach effectively allows asset owners to ensure that the ESG risks and opportunities in their investee companies are being appropriately managed. Peter Drucker, who was world-renowned for his innovative thinking in the ways of business management, once said, “What gets measured, gets managed.” The process for evaluating an ESG manager is similar to the process an ESG fund manager engages in when evaluating a company — you do your background research and then you meet the management team face to face and ask hard questions, helping to identify the real ESG managers with a truly sustainable business model.