Alistair Byrne, head of retirement strategy at State Street Global Advisors, explains why asset managers should look into environmental, social and governance exclusions, alongside an active asset stewardship policy.
It is now clear that the incorporation of ESG factors is consistent with fiduciary duty, helping to mitigate portfolio risks. An exclusionary approach — where the investment manager excludes certain companies from the portfolio on ESG grounds — is one option that is seeing interest and that can resonate with members.
Pension savers of all ages are increasingly querying where the money in their pot is invested. This groundswell of support for ESG is understandable and indeed reflects broader engagement with the sector from within the industry and wider society.
It is now incumbent on managers, index providers and the sector as a whole to work together to deliver practical and effective ESG investment options for schemes to adopt
With that said, the process of exclusion is not necessarily that simple and raises a raft of practical questions. Who decides what counts as a ‘bad performer’ on ESG? And where do we draw the line on companies that should be excluded and those that should not?
Exclusion is usually best deployed to exclude companies that show repeated and systemic failings in ESG performance. It can be rolled out on a sector-based approach or in alignment with external standards set by an independent body.
For example, SSGA announced recently that it planned to exclude controversial weapons producers, as well as organisations that routinely contravene the UN Global Compact principles, from Europe-domiciled funds totalling more than £20bn of assets under management.
The use of external standards of this nature can help to provide an effective framework for managers. It is also crucial to have best-in-class ESG data to make analysis on the activities of the companies in question.
Exclusion is just one tool in the ESG box
While exclusion is a simple and convenient mechanism and certainly one that trustees and scheme members can grasp easily, it does not on its own form an entire ESG investment strategy.
Rather, exclusion should sit alongside active asset stewardship as one tool in the ESG box. To achieve genuine and meaningful movement on ESG metrics, managers must also work with the companies in which they invest, helping to raise the bar of best practice and affect meaningful change.
This will involve a combination of dialogue and engagement, backed up by the power of voting on resolutions and director elections at company general meetings. Trustees are increasingly reviewing and challenging asset managers’ stewardship policies and track records, seeking alignment with their own principles.
The case for engagement
Take the shift in attitudes around renewable energy, for example. Now widely accepted as essential for the future of the planet, the move to greener energy is gaining pace.
This is of course a product of a concerted effort by numerous parties — from the UN to individual governments, to the sector itself and indeed the financial institutions that invest in that sector.
The vast infrastructure of the energy sector’s major players is a vital base from which to facilitate the shift to renewables, and investors in the sector have a key role to play in encouraging and driving the transition. In many cases, that engagement will prove more powerful than excluding the companies from the portfolio.
That said, there may still be a case for excluding the worst offenders and companies that do respond to investors’ requests for change and development.
The trend is increasingly clear: demand for ESG principles is growing. Schemes are on a journey in terms of developing and implementing their ESG policies and approaches.
It is now incumbent on managers, index providers and the sector as a whole to work together to deliver practical and effective ESG investment options for schemes to adopt, backed up by a cohesive and effective stewardship policy to deliver much-needed change in corporate behaviour and practices.
Index-based options will find a place alongside more active strategies, given the need for low cost and value for money.
Alistair Byrne is head of retirement strategy at State Street Global Advisors
