Since the emergence of “Modern Portfolio Theory” and the “Capital Asset Pricing Model” in the late 1960s, institutional investors have taken a quantitatively driven approach to portfolio construction, looking to create portfolio diversification and obtain better risk-adjusted returns by balancing their asset-class exposures. This journey has seen several important advancements in thinking about how to optimally achieve desired results.
Funds that want to take the total portfolio approach first need to get the total portfolio view. To do that they not only need data – and lots of it – but a rock-solid understanding of exactly how they’re going to use it.
Gaps in ESG investing
Most fund managers or asset owners you may question to about ESG have probably stated that they are a signatory of the UN PRI at the very beginning of the conversation. Most likely, this would be mentioned as evidence of their broader commitment to ESG investing. Some would then proceed to elaborate on their systematic consideration of governance and proxy voting. In addition to these two activities, others would discuss engagement and their collaboration with other investors, while some would provide a lot of details on how they analyse ESG factors and the way these are considered in the process.
In other words, you would find that ESG approaches and depth of analysis of ESG factors would vary vastly from one UN PRI signatory to another. Why is this so? What does a UN PRI signature really mean from an ESG perspective?
The UN PRI is an international organization that was launched in 2006 with support from the UN to promote the incorporation of environmental, social and corporate governance factors (ESG). Over time the PRI Initiative has attracted a large number of high profile signatories and has become the leading global network for investors to publicly demonstrate their pledge to responsible investing. As of now, it is estimated that the PRI has almost 3,000 institutions representing around $US100 trillion in AUM.
By becoming an UN PRI signatory, an investor commits to 6 principles. These are as follows:
- Incorporate ESG issues into investment analysis and decision-making processes.
- Be active owners and incorporate ESG issues into our ownership policies and practices.
- Seek appropriate disclosure on ESG issues by the entities in which we invest.
- Promote acceptance and implementation of the Principles within the investment industry.
- Work together to enhance our effectiveness in implementing the Principles.
- Report on our activities and progress towards implementing the Principles.
These principles are voluntary and aspirational in nature. As cited in one of the PRI documents, “the PRI is also, however, a ‘big tent’ organisation with a diverse set of signatories and an intentionally aspirational structure. The organisation encourages greater ambition amongst its signatory base while respecting the differences among members, whether due to size, sector or location”.
In this light, the UN PRI has offered a menu of possible actions under each of these principles recognising that a responsible investment strategy must be tailored to fit each organization’s investment approach and resources.
For example, under the first principle, a signatory could do several things to demonstrate the incorporation of ESG factors into their investment approach. These range from addressing ESG issues in investment policy statements; developing ESG-related tools, metrics, and analyses; encouraging academic, and other research on the theme to providing ESG training for investment professional, etc.
Among the possible actions outlined under the second principle, exercising voting rights and engaging with companies are the two that seem to be widely adopted within the larger UN PRI signatories.
Note also that Principle 1 talks about incorporation rather than integration of ESG. While the former indicates the inclusion of ESG factors, the latter entails more in-depth and more coordinated consideration of ESG factors into the overall process. ESG integration is viewed as a distinct approach within responsible investments and is widely used by a large number of participants.
The UN PRI outlines a list of ESG factors (see below) to be considered by the signatories. However, the list is not considered exhaustive nor there is a prescriptive manual about how these factors should be incorporated. To their credit, they provide extensive resources supporting the signatories and the wider investment community in implementing the principles and ESG investing in real world situation.
Because of the nature of the principles design, the UN PRI signatory status on its own would give little comfort to any investor who is serious about ESG and/or is looking to achieve specific ESG outcomes. They would need to dig in deep and wide into the signatories’ investment approach and process to determine the extent to which is ESG considered.
As ESG continues to expand and evolve, investors have started to demand higher standards and increased transparency on how underlying strategies and investments deliver real stakeholder benefits. This will particularly apply to UN PRI signatories, many of whom have fallen short of investing in alignment with the principles to which they have committed to.
