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Setting standards for responsible investing/ESG

There is much talk these days about responsible investing and environmental, social and governance factors. Like quality and excellence, who could really be against a better society and a more sustainable environment? But while nearly everyone agrees in principle, managers and allocators — and certainly the companies in which they invest — have yet to agree on a common definition of what constitutes an RI/ESG investment approach.

The Chartered Alternative Investment Analyst Association recently surveyed its global member base in conjunction with Zurich-based private equity manager Adveq to see what could be learned about the current thinking on RI/ESG from a population represented by asset owners and money managers in more than 90 different countries. While almost 80% of the respondents saw it as more important than it was just three years ago (and an even higher percentage indicate this importance will grow in the near term), it was clear from the survey there is still much work to be done to build a consensus around RI/ESG as an investment approach.

Most telling was that only 17% of responding asset managers — and an even lower share, 7%, of asset owners — were “very clear about the level of understanding about RI/ESG.” A related corollary about the lack of clear industry standards put an exclamation mark on this point: fully 84% of responding members felt there were no clear industry standards. The absence of what is perceived to be standardized and comparable data, and a greater need for product education, were also noted by the vast majority of the respondents.

The survey results clearly showed the demonstrated interest in RI/ESG, but the noted gaps will continue to be impediments to implementation, particularly as more retail-oriented assets look to move into this area.

The concept of ESG has been around for decades. Specific origins tied to big asset owners could be seen with trade union pension plans in the 1950s interested in better outcomes for health facilities and affordable housing. That was followed by the development of the Sullivan Principles in the 1970s in response to the atrocities occurring under the system of apartheid in South Africa. These developments largely ushered in a period of large asset owners using their capital to influence outcomes mostly by exclusion, via the withdrawal from any enterprise associated with undesirable behavior. It was largely effective and the assets in the global “ESG by exclusion” category are about $15 trillion today, according to the Global Sustainable Investment Alliance. It's an impressive amount, but given a history that goes back nearly 70 years, it is fair to ask why we have not seen greater adoption.

Critical mass

The GSIA put the level of global sustainable assets under management at just less than $23 trillion as of the end of 2016. It is clear by the level of assets under management that RI/ESG has achieved critical mass, creating an investment force to be reckoned with. Europe is far and away the dominant player, representing over 50% of the AUM. The U.S. is a distant second, with 38%, while no other region in the world is above 5%. It seems Europe has figured out the long-term value proposition of ESG better than the rest of the world, as investors there have long viewed ESG as part of their fiduciary responsibility. The slower start in the U.S. is attributable to the Department of Labor's issuance only late last year of new and clarifying guidance to fiduciaries about investment policy statements and proxy voting guidelines. The U.S. is also a market where “short-termism” is rewarded, or punished, as represented by a simple quarterly earnings release or revised earnings-per-share guidance.

It is also interesting to note that while the institutional assets dominate the global RI/ESG assets, retail investors are coming on strong, with their share of RI/ESG-dedicated assets doubling in just the last two years. As historically more traditional defined benefit plans continue to yield market share to defined contribution assets, coupled with the baby-boomer generational transfer of wealth (estimated to be $25 trillion to $30 trillion over the next 30 years), the retail market will be a substantial part of the future growth story. In this space, more uniform measurements and a much clearer path to understanding the source of the alpha will need to evolve.

Allocators of all sizes, and the resultant message that has been sent to their respective asset managers, seem very clear about their intent and a perpetual commitment to this space. These growing mandates will need to be met by a corporate mindset that is more specific, measurable and uniform with the result that short-term capitalism might need to yield to a very different kind of longer term value creation.

The scientific evidence around climate change, global warming and an inelastic water supply against the backdrop of a rapidly developing global middle class are irrefutable. Today's leaders can continue to ignore evidence of climate change, but in doing so simply leave to future generations to deal with the repercussions of inaction. Short-termism must yield to today's reality because an uncovered short of this magnitude has unlimited downside risk, and the only hedge is a sustainable commitment by all of our global allocators, asset managers, CEOs, regulators and other policymaking bodies to make responsible investing a priority.

William J. Kelly is the Amherst, Mass.-based CEO of the Chartered Alternative Investment Analyst Association. This content represents the views of the author. It was submitted and edited under Pensions & Investments guidelines, but is not a product of P&I's editorial team.