Verifying ESG results key, including for asset owners

As DWS Group deals with the aftermath of allegations that it misrepresented its ESG investing assets, asset owners and money managers are feeling pressure to dig deeper to make sure they are receiving the intended results.

DWS is disputing the accusations, including inadequate ESG tracking, made by its former head of sustainability that are now being investigated by German and, according to Bloomberg, U.S. regulators. Deutsche Bank is the majority owner of DWS, which has €859 billion ($1.02 trillion) in assets under management.

"What the DWS situation really reminds us as analysts is to ask," said Hortense Bioy, London-based global director of sustainability research for Morningstar Inc. "It's not enough to have policy. You can find evidence in the data but it doesn't tell you the whole thing."

Knowing how fund managers track their ESG activities and monitor managers "is a great question that institutional investors should ask," Ms. Bioy said. "Do you have a tracking policy? How do you make sure it is applied?"

Asset managers like to talk about their ESG policy, "but it is not enough. This is a starting point," she said. "What you really want to spend a lot of time on is the process."

For Adam Gillett, head of sustainable investment for Willis Towers Watson PLC in London, which has $3.5 trillion in total assets under advisement, investors need to study a manager's culture. "That gives you a real tell about whether they are going to be able to continue innovating and integrating ESG," he said.

Ms. Bioy said analysts need to do all that but so do investors. "It's more homework for the investors. Portfolio managers have to submit reports, but they can always cherry pick. It requires the investors to ask the challenging questions."

That is fine with Rob Harley, a portfolio manager with the sustainable funds group at Stewart Investors in Edinburgh, with $24.8 billion under management. "We value when our clients are challenging us. Our reporting can always improve. I think everybody has got a responsibility to not accept things at face value. The same way we are spending a great amount of time researching companies and making decisions, we like our clients to be doing the same with us," Mr. Harley said.

Stewart Investors also offers an interactive holdings map that shows investors what specific strategies and funds are delivering in sustainable terms.

In November, Morningstar launched a qualitative measure of how well strategies and managers address commitment to ESG.

Actively managed strategies are rated on process (45% of the rating), resources (35%) and asset manager capabilities (20%), while asset managers are rated for their philosophy and process (40%), resources (30%) and level of active ownership (30%).

So far, Morningstar is proving to be a tough grader. Out of 31 asset managers assessed in 2021, only one — Australia's Affirmative Investment Management — earned the top "leader" status, followed by five firms at the "advanced" level: Amundi, BNP Paribas Asset Management, HSBC Global Asset Management, Jupiter Asset Management and Legal & General Investment Management Ltd.

In November 2020, Morningstar assessed 40 managers and awarded the top “leader” status to Australian Ethical, Calvert Research and Management, Impax Asset Management LLC, Parnassus Investments, Robeco and Stewart Investors.

New ratings from Fitch Group's Sustainable Fitch take a similar approach, assessing ESG performance at the entity, instrument and framework levels to allow investors to compare strategies and managers in more detail.

Regulators are also expected to help investors figure out what their ESG investments are accomplishing. In the U.S., Securities and Exchange Commission staff are considering what additional disclosures to seek from fund managers about the criteria used for branding investments sustainable.

In the U.K., regulators are not hesitating. In July, managers of ESG funds received notice from the Financial Conduct Authority that it expects to see "material improvements" in fund applications, many of which "often contain claims that do not bear scrutiny." The FCA warning also set the stage for further scrutiny and rules.

In the European Union, asset managers are revising ESG product classifications to meet sustainable finance disclosure rules that took effect in March, a process that can shrink ESG assets in an instant if they do meet the new criteria.

The rules relevant for investment management "definitely will drive greater disclosure and transparency. The expectations are that you will be proving what you are doing," said Michael Marks, head of responsible investment integration for LGIM in London, with $1.83 trillion under management.

"The fact that clients are asking for this now is as important as any regulatory driver. This will be an ongoing journey to make sure we are doing what we are saying we are doing," Mr. Marks said. "The factor that I think we will see become critical is authenticity."

To Adrienne Lawler, founder of the Responsible Asset Owners Global Symposium in London, it is all moving in the right direction. "I think it's a question of, 'We asked you nicely; now we're telling you,'" she said.

Ms. Lawler would like to see investment consultants take a bigger part in helping asset owners evaluate their managers on ESG. "They should be helping each side, helping them to see what's really helping and what's just stuff," Ms. Lawler said.

Mr. Gillett of Willis Towers Watson agrees. "We've got a big role to play. If you are an asset owner, whoever you work with, you want to make sure they have sustainability competencies" as well, he said.

Institutional investment consulting firms have joined forces in the U.S. and U.K. to promote and improve sustainable investment practices through working groups that are seeking "genuinely sustainable" investment outcomes, and a guiding set of principles for good practice and practical advice, among other goals.

Asset owners are also collaborating more to improve ESG analytics, Mr. Gillett said. "They realize it's in everyone's interests to get this right. They can't immunize themselves. That means you've got to build the system," he said. "There are big parts of the process that could be simplified."

Many asset managers are working to get better data and analytics, said Elizabeth Seeger, managing director for sustainable investing with KKR & Co. Inc. in Washington, in the firm's latest ESG report. While "we are collectively experiencing some growing pains," she said, "we think it is through constructive dialogue and cross-sector collaboration that we can keep ourselves accountable and aim for real progress."

Until that day, the best policy is "trust but verify," said Matt Orsagh, a senior director of capital markets policy with the CFA Institute in Charlottesville, Va. "And have someone who can do the verifying, someone with the experience to know what to ask."

"It's a change in investing culture and cultural changes take time. Five or 10 years from now I think information will be better. We will get there," Mr. Orsagh said.