Money managers and institutional investors are pushing their way to the edge of the next step for ESG investing: making sure it works.
Even as more managers and investors have busied themselves in recent years with integrating environmental, social and governance factors into their investment decision-making processes, a clear approach to measuring whether that integration adds financial — or extra-financial — value to portfolios has yet to develop.
“There is still a lack of evidence around how these processes work, and if they work,” said one ESG expert speaking anonymously. “I'm worried we are patting ourselves on the back too soon.”
Therese Niklasson, head of ESG research at Investec Asset Management Ltd. in London, said: “The industry has been eager to tell the world and its clients that we have this all figured out; (however) we are yet some way from having measurable processes which continuously demonstrate added value.”
Part of the problem is that it's just too soon. Many managers have created their integration programs (Pensions & Investments, April 5, 2010), or, like Investec, are in the process of doing so.
However, efforts are under way to address the issue of measurement. As far back as May 2008, Pictet Asset Management showed in a white paper that a portfolio composed of best-in-class greenhouse-gas-emitting companies produced nearly 35% less carbon dioxide than companies in a traditional benchmark portfolio.
Money managers such as RCM Capital Management LLC, AXA Investment Managers SA and Schroder Investment Management Ltd. are working on ways to measure how ESG integration affects either investment returns or the sustainability of portfolios.
At the heart of the measurement problem is the lack of corporate disclosure on environmental and social metrics, such as water usage.
For instance, while 91 of the largest 100 U.K. companies tout high standards of business ethics and integrity in their annual reports, just eight provide a specific metric of the company's ethical performance, according to a December study by the Chartered Institute of Internal Auditors.
“By providing specific measurements of their ethical performance, companies enable investors to monitor changes in performance, and potentially also to compare an organization with its peers,” according to the study.
In May, sports clothing retailer PUMA AG emerged as a leader in this area when it disclosed its first environmental profit-and-loss statement based on 2010 business results. The company found its operations and suppliers produced greenhouse gas emissions and water consumption with a “direct ecological impact” worth e94.4 million ($120 million).
“By putting a monetary value on the environmental impacts, PUMA is preparing for potential future legislation such as disclosure requirements,” according to a company statement at the time. “These costs will serve as a metric for the company when aiming to mitigate the footprint of PUMA's operations and all supply chain levels and will not affect PUMA's net earnings.”