By Maria Long, Content Director, The Standards Board for Alternative Investments (SBAI)
Responsible Investment (“RI”), also known as ESG Investing or Sustainable Investing, is a growing area of interest for asset managers, allocators, and regulators. Historically RI was associated with value-based exclusions of specific securities or sectors from a portfolio, but with awareness of RI issues growing globally, a wide spectrum of RI Approaches has emerged. These approaches account for strategy-specific characteristics and the growing diversity of allocator requirements.
RI-related factors have long been present in fundamental analysis, without being explicitly named so, but allocators now increasingly expect managers to develop an RI Approach and to document this approach in a well-defined RI Policy. The SBAI’s RI Policy Framework, published in the SBAI Toolbox provides managers with detailed non-prescriptive guidance to help them develop their RI Approach and document it in an RI Policy. Key findings from this work are detailed below.
Foundations of an RI Approach
Managers need to consider many factors when developing an RI Approach, including identifying key drivers which may include investor or regulatory expectations and the applicability of RI factors to the specific strategy. Managers also must understand the resource and data requirements for the proposed approach as implementing an approach without adequate resources will make it difficult for managers to assuage concerns over “greenwashing.” Data continues to be a challenge for some strategies, and careful consideration will need to be given to the availability of data or the resources required to source data independently.
Integration of RI-related factors into investment processes, where financially material, is a growing expectation by allocators. Robust asset valuation and risk processes should include all relevant financial and non-financial information so this should not be controversial; many RI factors are simply 21st-century risks. The key distinction between this and other RI approaches is that RI factors are not used to pre-define an asset universe.
Responsible Asset Selection
For dedicated RI products, managers may choose to pre-define the asset universe based on RI factors using exclusion lists, inclusion lists, or an impact investing approach. Exclusion lists are well known and may be a relatively simple way of approaching RI; however, there are questions over the effectiveness of this approach including whether engagement may be more impactful and the loss of nuance when considering investments. Inclusion lists, where assets are chosen either because they score relatively better on ESG metrics or are from sectors considered to be “green,” contain many of the same challenges but provide more opportunities for engagement to drive change. Conversely, inclusion strategies can present different challenges such as crowded trades and overvaluation of assets (particularly with large passive flows in this space). Exclusion and inclusion are not mutually exclusive and some combination of the two may be used as an RI Approach. Impact investing with the specific goal of delivering meaningful societal or environmental outcomes is growing in popularity. It requires clear and measurable impact goals, such as alignment with the UN Sustainable Development Goals.
Responsible Asset Ownership
Voting can be a key part of an approach to RI. Managers should have policies on how to vote on matters directly related to RI, but also whether seemingly non-related votes such as board reappointments should be linked to RI-related goals. Engagement has traditionally been viewed through a direct lens where managers attend company meetings where they can push for change. This approach can be effective but is limited to certain strategies and asset classes (e.g., concentrated long equity positions). Managers outside of these strategies can approach engagement at a more holistic level by engaging with regulators, exchanges, and industry organizations such as the SBAI. Activism is a more extreme form of engagement typically only available to managers with the required resources and relatively concentrated equity portfolios.
Responsible Corporate and Market Citizenship
Being a responsible investor is not limited to the investment process. There are many other ways that managers can demonstrate commitment to RI-related goals. This may include organizational initiatives to address environmental, social, and governance issues. Carbon hedging or offset is another method that can be used. Although discussions on whether this is effective include whether this is absolving responsibility without making changes and that carbon emissions funded via the investment process are likely far higher than those generated by the firm. Firms should also consider their behavior in and impact on the market to ensure that they contributing to reliable and fair markets.
Governance, Measurement, and Disclosure
Any effective RI Policy needs to be properly governed, measured, and disclosed to investors. This process starts with defining measurable goals to monitor the product in relation to the stated RI objectives. This may include benchmarking or tracking of ESG ratings in the portfolio over time. Measurement of impact portfolios has additional challenges with all measurements likely to be subjective. Having a committee or forum to discuss impact achievement may add robustness to this process.
Oversight of the process will be key to governance. This may be via an ESG committee in larger firms or involve multiple teams such as the investment team and compliance. In general, allocators will expect involvement from the investment team in oversight of RI to ensure it is fully integrated with the investment process. Oversight of RI processes may require specific knowledge and understanding of the issues; therefore, training (or the hiring of experienced talent) will likely be required.
Disclosure to investors is also critical. It is becoming a minimum expected standard for managers to have a detailed RI policy in place. The level of detail required in a policy will be dependent on a number of factors such as whether the product has an ESG focus or not. Allocators are also likely to expect a more detailed policy where RI integration is more material to the portfolio, for example in equity or buy-and-hold strategies. Strategies where RI integration has limited financial materiality (for example, systematic short-term trading strategies) would not require the same level of detail. The SBAI Toolbox memo provides a detailed framework of the types of disclosures that should be included within an RI Policy.
About The SBAI
The Standards Board for Alternative Investments (SBAI) is a neutral standard-setting and guidance body for the alternative investment industry. As well as acting as custodian of the Alternative Investment Standards, the SBAI hosts multiple working groups and events where asset managers and allocators can come together to discuss and solve for the key trends and issues impacting the industry. This helps maintain a positive reputation for the industry, enhance investor due diligence, and act as a complement to public policy and regulation.