“Asset managers should reallocate at least 30% of their ‘Responsible Investment’ marketing budget to internal ESG training for portfolio managers to avoid awkward situations that we have with them”. 
-CIO, French asset owner 

United Nations Principles for Responsible Investment Panel, Paris, April 2018 

Looking at the number of press releases regarding funds being launched, or relabelled, as “sustainable” or “responsible”, as well as the number of environmental, social and governance (ESG) jobs being posted on asset manager websites, there is little doubt that “Responsible Investment” (RI) has become a significant trend in the industry over the past 18 months. This seems to hold equally true across nearly all asset classes and regions. Even some asset managers who had never previously discussed ESG, now claim to have been “naturally” integrating ESG criteria for decades because it is “synergetic” to the way they have always invested. 

Given how prevalent ESG-related questions have become in requests for proposals, it is to a certain extent understandable that asset managers are trying to articulate what, in truth, has become “a license to operate”. But given the industry’s track-record, is it not fair to wonder if those in our industry are in danger of promising too much or outright misrepresenting their ESG records. What would the repercussions be if investors believe that companies are “greenwashing”, i.e. portraying their products, activities or policies as environmentally friendly when in reality they are not (1) in order to appeal to a growing segment of their customers? One clue may be found in leaked news from The Financial Times that the United Nations Principles for Responsible Investment (UNPRI) recently compiled a non-public list of 185 investors that could be excluded from their signatories due to potential greenwashing (2).

Clearly some corporations may be able to successfully spin a nice “sustainability” story for a bit of time. However, when it comes to the companies that we follow, Comgest conducts in-depth research in an effort to distinguish those companies that we believe offer sincere and serious ESG approaches. Based on our experience, we therefore offer the below hints to help asset owners and other investors with their own research. 

Firstly, in assessing the responsible investment strategy and ESG performance of an asset manager, we recommend using the “smell test” (3), which simply means asking yourself: Does this RI strategy makes sense in the context of everything else the asset manager does and reports upon? 

You can then start forming your opinion by asking the portfolio managers and financial analysts – not the ESG specialists – questions such as: Why are you doing all of this? What’s in it for you? These basic inquiries may be answered very differently by people within the organisation, without anyone providing the true answer: to grow their assets. Another round of open questions could be, How does this fit into your financial investment process? Can you provide evidence of your ESG impact? Will I get any financial returns from this? Once you have their answers, you can begin to ask more precise and targeted questions, which should be responded to with numbers.  

If truth be told, most ESG considerations do not show financial materiality for a few quarters. They generally start to matter over three to five years, or more, and just a handful of asset managers can afford to think over such long time frames. Comgest would argue that claiming to integrate ESG and holding companies on average for a year or less does not make sense. Asking about the portfolio’s turnover is a good start towards assessing an asset manager’s candour on how material ESG is to improve the risk-reward of his or her investments. 

In a similar manner, if ESG integration is so beneficial to the returns of their socially responsible investing (SRI) funds, then why would ESG integration not be systematically deployed across all funds of the firm and only to their SRI product line? Does this not risk a breach of fiduciary duty? 

Regarding a company’s investment process and research, one telling question to ask is how the asset manager sources its ESG research. Is it mostly internal research or via external ESG research providers? In our experience, there is no substitute to internal research if ESG is considered critical, just as it would be extremely difficult for a truly active manager to use only broker research without some internal expertise to form one’s own opinion and actions. 

Some portfolio managers have been told to learn a couple of good ESG stories, and as such, if you ask them to discuss the last time that their ESG integration led to a poor investment decision, they may be taken off-guard. Another way of phrasing the question is to ask, Could you tell us what you think is not currently working in your ESG integration? What have you tried, but stopped doing, because there were better ways to allocate resources? If taken seriously, ESG integration remains a trial and error exercise and should be clearly explained. 

In discussing engagement with companies, you should ask what an asset manager has done, or is doing, and what proved effective. Our smell test would be to ask, On what percentage of owned companies have you cast voting instructions? It is always surprising to hear from investors they engage with companies (in our view, usually in an opaque manner and with little effect in the end), but they only vote on a rather small percentage of annual general meetings (4) (AGMs) in which they could vote. To us, one of the first responsibilities of an investor is to vote. Indeed, an investor’s voting right can send a strong signal or even force change through the board, particularly when a vote is exercised with a clear explanation for its rationale.

To assess how engaged an asset manager is through their voting activity, another relevant query would be, What is the percentage of votes cast against management and the board, and on what types of items? To assess how responsible the voting activity is another query could be, What is the percentage of votes that follow your voting policy? In our experience, no matter how sophisticated a voting policy may be, there will always be instances where it should not be applied due to the respective circumstances of a given company. Depending on the case, the vote may need to be stricter or looser than what the voting policy recommends. In our view, investors that vote 100 per cent in line with their voting policy may be at risk of voting irresponsibly. That said, it is our view that in most cases voting at AGMs and company engagement should go hand in hand.

Consequently, investing responsibly and sustainably should in theory result in portfolios that are rather different and in a better position than comparative benchmarks in terms of various ESG metrics such as carbon footprints, net job creation or tax rates that companies in the portfolio pay versus their taxes owed. If the portfolios do not meet these “responsible” characteristics, then doesn’t it stand to reason that the portfolio may be greenwashing? 

This material is for information purposes only and is not intended as an offer or solicitation with respect to the purchase or sale of any security. The contents of this document should not be treated as advice in relation to any potential investment. All opinions and estimates are current opinions only and are subject to change.

Footnotes

1, Read more: Greenwashing. Investopedia. 09 Jul 2018.

2, Thompson, Jennifer. “UN responsible investing body threatens to kick out laggards.” The Financial Times. (subscription). 28 May 2018.

3, A “smell test” refers to an informal method for determining whether something is authentic, credible, or ethical, by using one's common sense.

4, In France, and according to the Association Française de la Gestion Financière (AFG), it is estimated that asset managers do not vote on more than 73 per cent of their investee companies as a percentage of their assets under management. When computed as a percentage of the number of holdings, it falls below 50 per cent. In the UK, no more than 72 per cent of the shares of the FTSE 250 companies are voted, and it falls below 50 per cent for companies outside the FTSE 250 (source: Equini). France and the UK can be considered as the two countries in Europe where voting activity is the strongest due to either hard or soft laws.

Comgest is a portfolio management company regulated by the Autorité des Marchés Financiers (AMF) whose registered office is at 17, square Edouard VII, 75009 Paris, France.