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Money Management

MSCI links ESG with stronger asset growth

Responsible investment a bonus for larger firms

John Belgrove said access to ESG data helps managers in stock-picking.

Being good stewards of client assets seems to pay off for some of the world's largest publicly traded money managers, with research showing a link between responsible investment and the power to gather assets under management.

Researchers at MSCI Inc., as part of its annual ratings review of the financial sector, considered a link between the environmental, social and governance ratings of 33 listed money managers and the growth of their assets under management over three periods: calendar year 2016; the two years to the end of 2016; and the three years to end-2016. The managers, representing $12.1 trillion in assets under management, are included in the MSCI World index.

The team at MSCI thought it would be interesting to see whether the most efficient money managers in terms of integrating ESG into investment processes really did have higher asset growth, said ​ Remy Briand, Geneva-based managing director, global head of ESG at MSCI. The team used its responsible investment key issue score, part of its own assessments, to look for a link.

"It's more for correlation than an analysis of causation. We can't say just with this particular analysis (managers are gathering assets) on ESG, and vice versa." He said analysis showed "some link between the score on responsible investment and the subsequent growth in assets under management."

For calendar 2016 the managers that scored the highest under MSCI's responsible investment assessment recorded an average compound annual growth rate of 3.7% in institutional assets under management, vs. a 1.8% decline for those with the lowest scores. Over the two years, the CAGR is 2.6% for the leaders vs. 1.6% for the lowest scorers; and for the three-year period, those with higher responsible investment scores saw 3.6% growth in AUM, vs. 0.3% growth.

Not a total surprise

While he added this is not a total surprise given the literature and existing studies on the topic of ESG and performance, Mr. Briand said it does signal that those managers with higher ESG scores were benefiting more than their peers with lower scores. This correlation might be "comforting" to money managers making an effort to integrate ESG factors, because one of the issues MSCI executives hear from money managers is whether they are being rewarded by asset owners.

"I would say there is a clear link on the institutional side, and the jury is still out whether on the retail side there is the same reward for people doing ESG," Mr. Briand said.

Sources and data suggest asset owners have a desire for their money managers to integrate ESG.

The Principles for Responsible Investment's 2017 Asset Owner Snapshot Report, published in December, found 68% of asset owners in its sample of 248 respondents encourage improved responsible investment practices with existing money managers, but only 19% have or would move assets to those with better integration.

About 20% of the sample were corporate retirement plans, of which 57% said they encourage improved practices with existing managers, but just 8% would move to a manager with better practices. Non-corporate retirement plans made up about 44% of the sample, and 73% of those plans said they encourage improved responsible investment practices. Of these, 16% said they would move to a money manager with better responsible investment practices.

And ESG is already a basic expectation among executives at the world's largest pension fund, the 156.8 trillion ($1.4 trillion) Government Pension Investment Fund, Tokyo. Speaking in September at a Principles for Responsible Investment event held in Berlin, Hiromichi Mizuno, executive managing director and chief investment officer, said officials have made it clear they expect the pension fund's money managers to become signatories of the PRI or explain why they do not need to; that they believe in ESG integration and expect all money managers to integrate ESG into their investment decisions; and that they ask money managers to engage with companies for significant ESG matters.

'Core to expectations'

The conversation also has developed on the asset owner side in Europe, said John Belgrove, London-based senior partner at Aon Hewitt. "I do believe ESG is a very important set of considerations for all long-term investors. Understanding the risks embedded in your portfolio along with the ESG aspects is becoming core to expectations as opposed to coming from a place that is niche."

Mr. Belgrove said understanding of ESG has evolved along with improvements and availability of data on the topic. "Access to (this data) means more information, (and) that helps managers to be able to select stocks and think about portfolio risks from those aspects."

On top of that, investment consultants are working harder in their own research. "Intermediaries like ourselves have been increasing our questions of managers on these aspects — our due diligence questions on the subject of ESG have been expanding period on period — maybe 30 or more questions specifically related to that form part of our assessment. We think incorporating ESG in decision-making is vital," Mr. Belgrove said.

Mercer Investments' manager research team assigns ESG ratings to each of the more than 5,500 investment strategies it covers. Sarika Goel, senior researcher for responsible investment strategies in London, said ESG ratings are awarded on a scale of 1 to 4 — one being the highest — and 15% of all ESG-rated strategies in 2017 were awarded ESG1 or ESG2, up from 9% of strategies for many years previous.

"The emphasis of ESG factors included in RFPs has increased meaningfully over the past decade," Ms. Goel said.

In the U.S., ESG principles have not historically been viewed as a "basic requirement" for traditional manager selection, wrote Andy Iseri, senior vice president and a non-U.S. investment consultant, and Mark Wood, vice president and U.S. equity investment consultant, both in Callan LLC's global manager research group in San Francisco, in an email.

"But things are changing. Right now, ESG principles are present for ESG-specific mandates, but for traditional mandates, ESG principles have yet to become a 'basic' requirement. It's Callan's opinion that eventually, ESG considerations will be as common as other traditional factors for more traditional mandates."

But they added they are "less certain about how important ESG considerations will be relative to traditional metrics. That is to say, Callan believes ESG will be part of a typical evaluation/selection process, but the importance of ESG required by U.S. investors, relative to, say, value and growth, is less certain," they wrote.

Concerns remain

While the executives expect ESG discussions to become more common in the U.S. this year, broad adoption or ESG emphasis is less certain. "Many of our clients are discussing incorporating limited ESG language as part of 'belief statements' in their review but not making it an explicit requirement in an investment policy statement."

U.S. asset owners are also still grappling with the concept of whether investing in an ESG-specific way might breach their fiduciary duty — despite guidance in 2015 stating that pension fund fiduciaries may consider ESG factors in their investment decisions without worrying about repercussions from the U.S. Department of Labor.

Jeb B. Doggett, a director with Casey Quirk, a practice of Deloitte Consulting LLP, in Darien, Conn., said the firm reaches out to plan sponsors on ESG and has sometimes heard back that while the concepts are attractive, the fiduciary duty to deliver the best returns means institutional investors "don't want to put constraints on managers, or don't want to project values onto the objectives of the (investment) program. The whole theme in concept is much more mature in Europe and the U.K."

Mr. Doggett said while there is evidence on both sides of the returns argument, "it really boils down to are institutional investors truly demanding it in a significant way. I think when you look at the assets that are allocated, there are token amounts within some plans. And so, if there's a performance give-up, managers are reticent. Some managers are investigating if their fundamental approach is consistent with the principles of ESG. Others are further away and thinking critically about whether they want to develop ESG or not."