Trustee boards’ best efforts to make meaningful progress on environmental, social and governance considerations are hamstrung by a lack of standardisation and a lack of integrated consultant ratings, writes Tegs Harding of Independent Trustee Services.
For many, equities are a natural place to start, and this is the area with the most choice for investors in how to invest sustainably. But those trustees looking to push forward with manager selection exercises for ESG investments may find themselves facing a conundrum.
The ESG domain of the investment universe is growing rapidly, and changing constantly — but one thing that holds true across the sector is that there is a real lack of uniformity as to the criteria that investment managers set for their ESG funds.
Given the pace of change in this sector, there would be merit in the industry coalescing around a shared set of standards
Even within the universe of passive sustainable funds there is a wide variety of approaches, with each fund targeting a slightly different benchmark.
This lack of standardisation makes it very difficult for trustees to weigh up the pros and cons of the various options and decide on any one approach. In effect, the trustees themselves are left to make their own minds up on the risk trade-offs.
Time horizons add complexity
I went through this recently with a board that was running a manager selection exercise, looking at four different funds. What came through was the extent to which encouraging boards to move beyond a traditional approach is made more challenging by the lack of standardised ESG criteria, and a lack of clarity on how far the fiduciary duty of trustees extends into the field of impact investing.
The scheme in question was looking at a buyout target of around eight years, which meant that the trustees decided to move towards a passive approach, because they had doubts that the engagement approach of the active manager would bear fruit over this relatively short timescale.
Even when the field is narrowed to passive approaches, the decision is still not straightforward. Trustees need to decide whether to focus on a zero-carbon approach or whether wider ESG factors are important to them.
Trustees also need a view of the degree of exclusion they are looking for. Typically, while this may mean exclusions only account for less than 5 per cent of the universe, the impact in terms of carbon reduction is still significant.
What is hard to judge is whether the balance of companies remaining in the portfolio is still sufficiently diverse. When you exclude the most carbon-intensive companies, you naturally end up with a fund that is overwhelmingly tilted towards US technology stocks.
Over recent years this has been a good thing and has helped deliver attractive returns. However, it is not clear that this pattern will hold over the next eight years — particularly given the growing regulatory attention being paid to the technology giants around the world.
Standards could help
Trustees need better clarity on objectives in order to have the confidence to invest more sustainably. Given the pace of change in this sector, there would be merit in the industry coalescing around a shared set of standards, giving trustees a proper, independent benchmark that they can trust.
I am open to ideas, but perhaps widespread adoption of the EU Climate Transition Benchmark would allow consistent measurement and hence facilitate easier decision-making for trustees.
Proposed RI bill would force trustees to consider members’ ‘best interests’
The leader of the Liberal Democrats supports a proposed responsible investment bill broadening the concept of fiduciary duty to encompass sustainability concerns and aim for a ‘world worth retiring into’.
The other piece of the puzzle that would help boards in their decision-making is consistent advice from consultants, with ESG factors fully embedded in ratings.
Consultants will tell you that climate change is a material financial risk, but ask what the expected return is and you get the same answer, whether you are talking about a passive market cap tracker or an active sustainable index with screening and a focus on impact investing.
We need forward-looking return estimates with climate factors built into the model, otherwise boards are left setting strategies based on a leap of faith.
Tegs Harding is a director at Independent Trustee Services
