In recent years, the concept of responsible investment (‘RI’) has started to gain traction across our industry. But as markets continue to transform – driven by shifting regulation, technological development and the changing needs of institutional investors – how should we think about building responsible strategies for the long term? Institutional investors are increasingly asking this question, faced with a tough challenge in de-coding a varying set of responses from the assetmanagement community. Indeed, despite progress in recent years, there remains little consensus about what responsible investment really means, or what it will take to ensure that these principles remain in focus through time.
This article sets out three elements which we believe are important in responsible investment. First, responsibility around environmental, social and governance (‘ESG’) factors must be integrated into mainstream investment processes, rather than used to create niche ‘ESG-labeled’ products. Second, we believe asset managers must be prepared to work flexibly with clients to determine the best ways of implementing RI – in everything from strategy design to the investment process itself. Third, and most important in our view, our industry must reconcile RI considerations with our broader responsibilities to investors – and in doing so, make the case for responsible investment in the context of performance, and even as a potential source of alpha. We believe that these principles can help support the case for responsible investment over the long term, and guide our industry’s approach along the way.
RI must be embedded into mainstream investment – niche products hamstring broader progress
In discussions about RI, some commentators point to products and strategies which are explicitly labeled as ESG-focused. The spread of these products might initially seem a positive indicator of progress towards responsibility in the investment industry, but in reality it is more complicated. At worst, it’s clear that some of these products are simply marketing gimmicks – exploiting investor interest while maintaining only a casual commitment to RI. Consider the proliferation of fashionable ‘clean tech’ funds during the financial crisis, for example, several of which later blew up. But at best, these explicitly ESG-focused strategies fail to influence the bigger picture – creating a niche experience for a narrow circle of investors, and limiting the reach of responsible investment principles more broadly. We believe that true progress in responsible investment means adopting these principles across mainstream strategies – so that RI becomes the norm, rather than the exception.
Working flexibly to incorporate RI – from strategy design to the investment process
Of course, integrating RI norms across mainstream investment strategies is no easy task – especially given the variance in client perspectives. Real integration requires a high degree of flexibility, not just in terms of how portfolio managers analyse their exposures, but also in how clients access strategies. For example, managed account structures have often been seen as a short-cut for investors to monitor and apply ESG criteria to existing strategies which may not normally incorporate them. This may be the right choice for some investors – but it’s unambitious, implicitly accepting that the strategies themselves are not capable of adopting RI themselves. At Man Group, we’re working increasingly with clients and investment teams to understand the impact of RI principles on commingled vehicles. In some cases, we are finding that existing strategies can adopt further RI principles without impacting their investment mandate or potential outcome – so we work with fund directors to agree and implement them.
It also takes flexibility to incorporate these norms into the investment process itself, where different strategies will require different approaches. For example, using negative screens to exclude certain exposures, or integrating more comprehensive ESG data within financial analysis, or engaging more actively with underlying companies, or a combination of these – the nature of each investment strategy will determine the best approach. There is no ‘correct’ way of doing this, but we believe what unites each of them is the need for good data. This can take many forms, and there are already a number of providers working to support investment managers in understanding the non-financial risks around companies. However, there is clearly room for improvement in the transparency of companies on metrics around responsibility, and regulators will have an important role to play over the coming years.
Reconciling RI with fiduciary duty
One of the most common concerns about incorporating RI principles into investment is its potential impact on performance. After all, investment managers have a fiduciary duty to act in the interests of all clients, in line with their mandated risk and return parameters. Some investors may assume that RI simply restricts a strategy’s investable universe, inevitably weakening performance through time and undermining this duty. However, responsible investment is about much more than simply excluding parts of the market – it can also involve looking for ‘virtue-signaling’, positive characteristics with the potential to support long-term company performance. Research remains in its early stages about the alpha-generative potential of RI, but we believe that in the coming years, the investment industry will increasingly look towards non-financial factors as a source of potential opportunity, and an additional lens for risk management. Growing amounts of data are helping to make the case for RI as a potential contribution to performance – and bringing a wider and more diverse set of people into the conversation – but beyond this, we believe it is no longer enough to assume that end investors (pension scheme members, for example) are blind to the issues of responsibility and the ethical footprint of their investment mandates. Indeed, we believe that the scope of fiduciary duty in investment is broadening, with many asset owners viewing commitment to RI as an important component.
Moving towards a fully integrated approach to RI
The investment industry still has a way to go in codifying its approach to RI – and we are beginning to see some formalised work here, for example in the industry-standard DDQ published by the UN-supported Principles for Responsible Investment earlier this year. Ultimately, we believe that these issues can be considered as part of every investment strategy – albeit applied in different ways.