Meeting the measurement challenge

For too long, asset owners have had few means of assessing the real environmental, social and governance skills of their asset managers. Jonathan Horton explains how a new benchmark can help both sides measure and manage ESG issues

The integration of environmental, social and corporate governance (ESG) issues into the investment process has, arguably, never been more urgent – and certainly has never been more discussed. Global investors are focusing increasingly on ESG issues, in particular climate change and environmental factors.The growing number of trade associations and investor initiatives – such as the UN Principles for Responsible Investment, the Carbon Disclosure Project and the UN Environment Programme Finance Initiative (UNEP FI) – provide testimony to this and, in turn, drive both pension fund beneficiary and trustee awareness and also create investment opportunities.

However, the effective integration of these issues into investment processes is a key challenge. As the UNEP FI asset manager working group and the World Business Council for Sustainable Development recently concluded,“capital markets will adequately capture and reflect corporate sustainability performance only if capital market makers – and all other actors along the investment chain – actually do integrate the ESG information”¹.

But this integration challenge is also a challenge of internal measurement and external communication. Until now, it has been difficult for asset owners to assess and measure the ESG skills and commitment of asset management organisations. Asset owners have had to rely on assessments of marketing presentations, the credentials of any ESG specialists and the claims made by the managers themselves.

At the same time, asset managers have had no effective independent method of measuring their ESG competencies and articulating this to their current and potential clients. ESG strategies appear to have often evolved with little consultation with clients. Managers have been unable to assess whether what they were doing was effective or how they were positioned relative to their peers.

Each benchmark is delineated by investment style. The benchmark shown is reflective of active management styles. The horizontal axis shows the headline asset manager rating together with five responsible investment themes. The vertical axis represents a measure of how well, on average, the manager universe assessed performed.

This lack of clarity creates uncertainty and makes it difficult for already over-burdened trustees to address this question and provide appropriate signals to asset managers. For asset managers that see business opportunities arising from superior ESG research and analysis, a key issue is how to leverage their resources and investment to win business and communicate their advantage to their target clients. For increasing numbers of asset owners, responsible investment is no longer simply an issue for those that have a strong sustainability or stewardship mandate; it has become a central question in relation to investment risk and return.

One reason as to why this integration challenge persists is the lack of effective “management tools” with which to measure and assess the process of incorporating ESG factors. It is easy at this point to recall Peter Drucker’s famous maxim “If you can’t measure it, you can’t manage it”, as it is as relevant to the effective execution of responsible investment practice as to any other area of investment management.

It is against this background that RImetrics, working alongside major European institutional investors, began to research, rank and rate asset managers. This work enabled the creation of the Responsible Investment Benchmark (RIB). This benchmark allows asset owners to evaluate, monitor and benchmark individual asset manager strengths and weaknesses in responsible investment practice. Data for this global indicator is gathered from a growing body of research that to date covers information compiled from global asset managers representing more than $12 trillion of assets under management and includes more than half of the world’s leading 20 managers.Using primary research, the assessment process involved collecting more than 130 different data points from each asset management organisation.

The RIB provides a measure of average industry performance across five key responsible investment themes (see figure 1):

• the manager’s strategic orientation in relation to responsible investment;
• its approach to engagement;
• the degree to which ESG information is integrated with its investment management processes;
• its proxy voting execution; and
• its own transparency and accountability.

As no two asset managers are the same, comparative measures of competence are essential. The RI benchmark examines various aspects of each manager’s responsible investment competencies and practices across the five key themes (see figure 2).

The benchmark is designed to assist asset owners and investment consultants with improving manager selection, meeting fiduciary and other member obligations, and delivering on ESG objectives. It will also assist asset managers wishing to gain insight into their own responsible investment competencies and practices and their positioning relative to their peers.

So what does the benchmark tell us about the industry as a whole? When the total scores for all asset managers are aggregated into the RI benchmark, we are able to see where the industry has made the most progress, and where there are still deficiencies. The strongest practices are to be found in proxy voting execution, while the weakest are in the integration of ESG information and analysis. The fact that the benchmark shows a downward curve from strategy though engagement to integration is very revealing. It suggests that, while managers are making an investment in ESG-related strategy and corporate engagement, it is not being integrated fully into their investment practice. In these circumstances, the ESG resource investment is not effectively being utilised and there is a high risk that ESG objectives may not be met. The benchmark data also suggest that, on average, asset management organisations are better at articulating a responsible investment strategy and providing policies than they are at putting them into operation.

At this point it provides a snapshot of the asset management industry globally. As the data set grows, the RIB will evolve to reflect the progress of the industry which, in many aspects, is still struggling to answer the “how do we do it?” question. Next year, we expect some changes in the profile and, over time, we will develop an understanding of how the industry globally is meeting the ESG integration challenge.

For RImetrics, real value lies in the creation of a benchmark that reveals relative positions and comparative strengths and weaknesses in a way that is relevant and easily understood by both manager and trustee. To do so, it is essential that benchmark data has sufficient depth to provide insights not only at the headline level, but also in relation to policies, practices, organisational structure, responsibilities, records, measurement and audits and, importantly, outcomes. In this way, an asset manager can obtain not simply a snapshot of overall competence but also a guide to those areas that may demand attention, strategic analysis or management intervention.

The benchmark provides up-to-date comparative analysis versus the asset management industry as a whole. We are already starting to see the practical value of this. Recently, RImetrics was asked by an asset owner whether a manager’s claim to offer the “best proxy voting service in the world” was credible. At that point, no one, including both parties concerned, had any way of verifying whether this assertion was correct. Based on benchmark data, we were able to show that the manager (Manager 6 in figure 3) was far from delivering on this claim; and in fact not only were its voting competencies and practices significantly far from being the best in the world, they were also below the industry average. This data enabled the owner to begin a more informed dialogue with the asset manager about its expectations, and enabled the manager to evaluate its proxy voting competencies critically.

On another occasion, a large asset owner wanted an assessment of the ESG competencies of a group of managers shortlisted for a particular global equity mandate. The assessment identified a small number of managers whose competencies in this area were particularly high. Based on this assessment, together with more traditional performance data, the asset owner was able to develop a clear methodology for selecting and short-listing managers.

In this way, asset owners and advisers can use asset manager ratings to gain a comprehensive assessment of individual asset managers’ responsible investment competencies and practices. This service can include peer group benchmarking and customised ratings.

For asset managers, the benchmark offers a comprehensive report and assessment service that enables them to better evaluate their investment in responsible investment competencies and practices. But there are costs associated with building responsible investment competencies, and these costs should and must be carefully evaluated. What use is effective engagement if the information gathered is never properly integrated into investment decisions?

Benchmarks can be helpful and relevant to all parties in the institutional investment industry. They provide tools that enable asset managers to carry out the essential strategic evaluations necessary to improve their capabilities, whilst at the same time enabling pension funds and other large asset owners to incorporate ESG competencies in their manager selection and appraisal decisions.

Transparent, robust measures of competence and practice in the delivery of environmental, social and governance engagement, research and proxy voting practices are of benefit to everyone. Only through measurement can the industry, regulators and commentators properly establish which asset managers are strong in this area and which are weak. Only through measurement can an asset manager’s competencies be challenged, and only by measurement can broader industry trends be evaluated year by year.

Jonathan Horton is CEO at RImetrics, a UK-based company specialising in the delivery of responsible investment ratings and benchmarks to the global investment community

1.World Business Council for Sustainable Development – UNEP FI Evaluation Workshop Outcomes, Montreux, March 2008