Creating a better future
ESG research: do investment professionals need more training?
More than half of the funds under management in Australia are managed by organisations who have committed to the United Nations Principles for Responsible Investment. While investment professionals working for these organisations are gradually acquiring the skills and expertise they need to conduct ESG analysis, they have not had access to any formal ongoing educational programs. As a result, responsible investment standards and practices vary significantly and there is no set definition of what is “best practice” with regard to ESG integration. In Australia, the Responsible Investment Academy has been established to meet this skills gap and assist in developing the profession by providing structured learning pathways, continuing professional development and opportunities for collaboration, research and innovation in responsible investment across the global responsible investment community.
Negative screenings are not the only way
Some companies typically appear in several sustainable equities indices. Similarly, there seems to be significant overlap between various funds’ sustainable equities portfolios. However, to therefore assume that the research and decision methodology used by research analysts is near identical is, in my view, a hasty conclusion.
Research on sustainable investments is often mistakenly assumed to be limited to negative screenings. A negative screening simply means that a fund refrains from investing in companies engaged in, for instance, the weapons industry, pornography or alcohol and tobacco.
Two and a half years ago a colleague and I started a research product on sustainable companies in Scandinavia. The aim was to incorporate as many criteria as possible used by institutional investors. This proved to be a fairly complex task and while I believe the product has found a good and compromising middle ground, I would argue it is very difficult to produce a research product on socially responsible investments (“SRI”) that satisfies all investors.
Apart from negative screenings, which can vary significantly across funds, I have seen several other approaches in use in Europe, such as thematic focus, which looks at companies in certain industries, and positive screenings. The latter highlight companies that stand out in a positive way on environmental, social and governance (“ESG”) issues. Some include only companies that are above certain thresholds while others look at pioneers and significant improvers in naturally dirty industries.
Regardless of whether a positive or negative screening is used, the hurdles or criteria can also vary substantially. For instance, one particular fund might allow up to 10% of a portfolio company’s turnover come from alcohol- or tobacco-related operations while others might apply a zero-tolerance policy.
However, despite the multitude of analytical tools used, I am not surprised to see the same stocks in various funds’ portfolios. There are many reasons why.
Restricting a portfolio to contain only sustainable equities automatically limits the range of stocks a portfolio can contain. However, the scope becomes even narrower because many companies are slow or reluctant to report ESG issues. For instance, management often receives comprehensive questionnaires from SRI investors, which can be very detailed and are not standardised, so can be very time consuming for management to complete. Some larger companies have a dedicated team for ESG issues while many smaller companies do not have the resources in place.
In addition, smaller and under-researched growth companies in innovative clean technologies are often subject to limited liquidity in the stock market. Naturally, fund managers are reluctant to take relatively big positions in these companies. This is one reason why index-heavy companies become index-heavy in SRI portfolios as well. Also, on a somewhat different note, it is not strange that different fund managers sometimes find the same investment opportunities lucrative.
Better analytical tools needed in the future
Companies are increasingly reporting on ESG issues and stepping up their sustainability efforts. For instance, in the wake of the global financial crisis, many financial institutions are implementing policies on responsible lending (see my previous blog post on responsible lending). Some companies publish separate ESG reports and others have increased the ESG content in their annual reports.
The company brand benefits from featuring in sustainability indices and having SRI funds on the shareholder registrar works as a stamp of quality assurance, which in turn might attract more interest from other SRI investors.
Therefore, while the increased efforts on ESG are very encouraging, it also puts more pressure on analysts to distinguish between so-called greenwashing and genuinely responsible companies.
More than half of all funds under management in Australia have signed up to the United Nations Principles for Responsible Investment (“UN PRI”). From an international perspective this is a high number, which means that Australia has an opportunity to develop into a major centre for responsible investment. However, failure to capitalise on this opportunity could lead to reputational damage for Australia, as the fund management industry itself could be accused of greenwashing.
Responsible Investment academy in Australia
In light of this, the Responsible Investment Association Australasia (“RIAA”) is creating an academy for investment professionals. The Responsible Investment Academy (“RI Academy”) will provide structured learning pathways, continuing professional development and opportunities for collaboration, research and innovation in responsible investment across the world. RIAA is Australasia’s only not-for-profit industry association for fund managers, investment banks, financial advisers and superannuation funds offering responsible investment products and services and has already established the first (and still the only) responsible investment certification programme in the world.
The RI Academy has secured funding from the Government (AUD2.5m over three years) and will offer courses for both entry level and advanced participants initially focusing on two specific areas – the ESG factors influencing investment performance and the structural and strategic issues facing the industry as a whole.
The RI Academy is currently in the build phase and the planned launch date is early 2010.
Negative screenings are not the only way
Some companies typically appear in several sustainable equities indices. Similarly, there seems to be significant overlap between various funds’ sustainable equities portfolios. However, to therefore assume that the research and decision methodology used by research analysts is near identical is, in my view, a hasty conclusion.
Research on sustainable investments is often mistakenly assumed to be limited to negative screenings. A negative screening simply means that a fund refrains from investing in companies engaged in, for instance, the weapons industry, pornography or alcohol and tobacco.
Two and a half years ago a colleague and I started a research product on sustainable companies in Scandinavia. The aim was to incorporate as many criteria as possible used by institutional investors. This proved to be a fairly complex task and while I believe the product has found a good and compromising middle ground, I would argue it is very difficult to produce a research product on socially responsible investments (“SRI”) that satisfies all investors.
Apart from negative screenings, which can vary significantly across funds, I have seen several other approaches in use in Europe, such as thematic focus, which looks at companies in certain industries, and positive screenings. The latter highlight companies that stand out in a positive way on environmental, social and governance (“ESG”) issues. Some include only companies that are above certain thresholds while others look at pioneers and significant improvers in naturally dirty industries.
Regardless of whether a positive or negative screening is used, the hurdles or criteria can also vary substantially. For instance, one particular fund might allow up to 10% of a portfolio company’s turnover come from alcohol- or tobacco-related operations while others might apply a zero-tolerance policy.
However, despite the multitude of analytical tools used, I am not surprised to see the same stocks in various funds’ portfolios. There are many reasons why.
Restricting a portfolio to contain only sustainable equities automatically limits the range of stocks a portfolio can contain. However, the scope becomes even narrower because many companies are slow or reluctant to report ESG issues. For instance, management often receives comprehensive questionnaires from SRI investors, which can be very detailed and are not standardised, so can be very time consuming for management to complete. Some larger companies have a dedicated team for ESG issues while many smaller companies do not have the resources in place.
In addition, smaller and under-researched growth companies in innovative clean technologies are often subject to limited liquidity in the stock market. Naturally, fund managers are reluctant to take relatively big positions in these companies. This is one reason why index-heavy companies become index-heavy in SRI portfolios as well. Also, on a somewhat different note, it is not strange that different fund managers sometimes find the same investment opportunities lucrative.
Better analytical tools needed in the future
Companies are increasingly reporting on ESG issues and stepping up their sustainability efforts. For instance, in the wake of the global financial crisis, many financial institutions are implementing policies on responsible lending (see my previous blog post on responsible lending). Some companies publish separate ESG reports and others have increased the ESG content in their annual reports.
The company brand benefits from featuring in sustainability indices and having SRI funds on the shareholder registrar works as a stamp of quality assurance, which in turn might attract more interest from other SRI investors.
Therefore, while the increased efforts on ESG are very encouraging, it also puts more pressure on analysts to distinguish between so-called greenwashing and genuinely responsible companies.
More than half of all funds under management in Australia have signed up to the United Nations Principles for Responsible Investment (“UN PRI”). From an international perspective this is a high number, which means that Australia has an opportunity to develop into a major centre for responsible investment. However, failure to capitalise on this opportunity could lead to reputational damage for Australia, as the fund management industry itself could be accused of greenwashing.
Responsible Investment academy in Australia
In light of this, the Responsible Investment Association Australasia (“RIAA”) is creating an academy for investment professionals. The Responsible Investment Academy (“RI Academy”) will provide structured learning pathways, continuing professional development and opportunities for collaboration, research and innovation in responsible investment across the world. RIAA is Australasia’s only not-for-profit industry association for fund managers, investment banks, financial advisers and superannuation funds offering responsible investment products and services and has already established the first (and still the only) responsible investment certification programme in the world.
The RI Academy has secured funding from the Government (AUD2.5m over three years) and will offer courses for both entry level and advanced participants initially focusing on two specific areas – the ESG factors influencing investment performance and the structural and strategic issues facing the industry as a whole.
The RI Academy is currently in the build phase and the planned launch date is early 2010.
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