Beyond box-ticking and greenwashing: 6 steps to creating real value through ESG and responsible investing

With climate change effects and social issues becoming more visible and more tangible every day; governments introducing regulation to gradually transition to a more sustainable economy; and technologies enabling that transition progressing steadily, “responsible investment” is slowly but surely becoming the norm among asset owners.

In the trade, business and national press, we have seen increasing column inches dedicated to supporting voices for sustainable investment practices. This is not to mention the headlines that can be the result of the reputational risk entered into by those that do not take the necessary precautions to ensure they are not unwittingly funding frowned-upon activities at portfolio companies or in their supply chain.

The number of signatories of the UN PRI (Principles for Responsible Investment) has increased to 450 Asset Owners and 1760 Asset Managers worldwide. The majority of large institutional investors actively measure impact and progress towards achieving the UN’s SDGs (Sustainable Development Goals) through its investments. And it is hard to find investors that don’t already consider ESG (environmental, social and governance factors) as a key issue, when selecting fund managers.

One of the issues that is increasingly troubling investors is the propensity of fund managers to claim ESG credentials that they do not deserve. Doing the absolute minimum or simply ‘ticking boxes’ is no longer suffered by investors.

Particularly in Europe, fund managers are recognizing that having an ESG policy, regardless of its quality, and demonstrating that they are acting upon it, is no longer enough.

Yet, it is clear that progress genuinely has been made. Nevertheless, the integration of ESG into the investment cycle – from initial screening, through holding, to exit – remains a challenge for many fund managers. A study indicated that less than half of fund managers continue management of ESG post investment. Once they are satisfied that they are not investing in something that is currently problematic, there is often little effort made to ensure that this remains the case, and to double check that information available prior to investment represents the true picture.

The wide scope of ESG metrics and sustainability frameworks and the lack of formal and uniform reporting requirements hinder the investment managers’ ability to derive real value from it, even though they acknowledge it is there. For too many, ESG, is a box-ticking exercise. Ultimately, this serves no one.

Forward-thinking fund managers and asset owners, however, are looking for more effective ways to incorporate environmentally and socially responsible practices, linked to their investment strategy and delivering real value – and impact.

Fund managers who have implemented a sophisticated ESG approach a number of years ago, are now experiencing the value creation in their portfolio as well as in their processes, including fund raising, of course. And with awareness on climate and social issues increasing by the day, the current generation of Investment Managers acknowledges there is no way back – these issues can simply not be ignored any more.

So, what does a more sophisticated version of ESG approach look like? What should fund managers and their investors be thinking about?

Here are six places to start.

1. Integrated

ESG must be tightly integrated into every stage of the investment process, from investment strategy, through screening and due diligence, portfolio value creation and exit.

2. Linked to the equity story

The materiality of each area of ESG should be considered and appropriately weighted, according to the equity story of each underlying portfolio company – some aspects will be more important than others, depending on sector, location, supply chain etc.

3. Fact-based targets

ESG is about targets, not themes, and the ESG programme must have at its heart specific targets that at are based on measurable activity and outcomes.

4. Compatible with market standards

Using established frameworks allows relevant parties to benchmark performance against other companies and funds in the portfolio.

5. Management driving the process

Management at the portfolio level is closer to the business than any investor can be and they should be incentivised and trusted to deliver the goals of the ESG programme.

6. Transparency

Activity and progress needs to be reported in a very clear way to all stakeholders, at the level of detail that is appropriate.

Any investor and fund manager not already working in this fashion is not truly employing ESG in a productive way. Quite apart form the risks that brings into the portfolio, it also ignores significant value creation possibilities.

To find out more about MJ Hudson Spring’s ESG services, please contact Matthijs Baan.