Head of Multi-Asset Strategy
Environmental, social and governance (ESG) investing has moved much closer to the centre of trustees’ and pension managers’ concerns over the past few years. To help trustees grappling with having to evidence implementation of their policies, we share how we are demonstrating ESG integration in our multi-asset portfolios.
From October 2020, trustees must produce an implementation report explaining how they have followed and acted on the investment policies outlined in their SIP. It’s not just regulators that are interested in these developments; members of DC pension schemes are now increasingly challenging trustees as to how their money is being invested. Schroders Global Investor Study 2019, which questioned over 25,000 individual investors globally, found that 61% believe all investment funds should consider sustainability factors.
While most asset managers are embracing sustainability, the resulting multiplicity of reporting methods presents schemes with a problem; reconciling different styles and formats of reports also makes it difficult to see the underlying picture. We have no easy answers, but believe the starting point is to understand how a manager is approaching integrating sustainability and then consider how different data sets and proprietary tools can build a picture that meets the requirement of regulators and members.
In 2019 we introduced the idea of a ‘sustainability budget’ and started to evaluate our multi-asset portfolios using this measure.
We believe trustees and pension managers should decide how much of their risk and governance capacity they want to devote to integrating sustainability into their portfolios. Essentially this is the amount of capital a scheme can devote to sustainable assets (the sustainability budget) and where they want to be placed on the sustainability spectrum (see Figure 1).
The trade-offs involved in establishing a sustainability budget revolve around removing or reducing asset classes and company components that are ‘unsustainable’ from the universe available for investment. This may be easy to comprehend, but it can reduce the portfolio’s diversification and increase volatility over the time period that many trustees evaluate their managers. Understanding this trade-off is an important part of integrating sustainability into a multi-asset portfolio.
Figure 1: How sustainable do you want to be?
Increasingly, we believe that multi-asset investing will go beyond just selecting asset class components that can be managed in a sustainable way. With ESG issues being integrated into the foundation of how asset allocation is decided, we have started on that journey, but are by no means at the end. We have looked at the implications of climate change on longterm returns, incorporating the results into our 30-year return forecasts published in March this year.1 These forecasts are now being incorporated into our portfolio construction process. Our medium term asset class research now incorporates views on ESG factors, and whether those factors could (or should) impact a position in a portfolio.
The work we have done so far strongly supports active management – there are going to be winners and losers in companies, governments and countries. Understanding these issues and incorporating this analysis into portfolios, especially those held for long periods, will be imperative to benefit from these long-term trends.
The starting point for measuring and reporting on sustainability is to understand how risks and issues have been integrated into the investment process. This knowledge allows trustees and pension managers to view the portfolio though a range of different sustainability lenses such as carbon intensity, gender diversity and employee treatment at work and the outcomes interpreted in a insightful manner. The challenge arises when we consider what the portfolio is being measured against and what data is being used. There are three main ways to do this: third party analysis, using publically available data or managers’ own measurement tools. If the tools being used are provided by a third party, their interpretation of the risks may differ from the manager. If measurement is only done using the manager’s proprietary tool, the outcome will reflect how the portfolio is being managed but won’t be easily comparable to other managers into which a scheme may invest.
Ultimately we feel that a sensible dual approach will help trustees meet their requirements. Simple reporting based on publicly available company data allows for comparison across different portfolios, with managers also providing more insightful measures using proprietary tools. Perhaps grouping these insights in terms of the UN Sustainable Development Goals2 could provide a powerful tool for trustees and pension managers to compare managers who are using very different investment processes.
One specific area of reporting is on engagement. Here we feel that trustees should expect not just a list of voting activity or basic engagement summaries from their asset managers, but comprehensive case studies. Engagement should demonstrate purpose of the engagement, collaboration if that was the route taken, and most importantly the outcome. Voting reporting should cover significant votes against management, highlighting the reason why and the objective trying to be achieved.
Whatever the approach taken, reports need to be tailored for the audience. Governments and regulators will require more detailed and quantitative information, whereas something simpler and easier to digest will work better for members (see Figure 2).
Figure 2: Tangible reporting for members
Incorporating sustainable investing into pensions is now no longer an option but a requirement. The tools to provide effective implementation and reporting are still a work in progress, with common standards some way off. At Schroders, we have integrated ESG across research, asset allocation, components and portfolio construction but there’s plenty more to do. As trustees, there is a lot to think about; Figure 3 highlights some of the tools that can be considered when integrating ESG. Trustees will need to decide which are most important to them and which fit with their investment philosophy.
It’s easy to throw a few funds together but ultimately does that give you a coherent ESG multiasset portfolio? We would argue not.
Figure 3: Embedding ESG into our multi-asset approach
1 How climate change may impact financial markets https://www.schroders.com/en/hk/institutional-service/insights/thought-leadership/how-climate-change-may-impact-financial-markets/
2 For more information, visit https://sustainabledevelopment.un.org/
Our business is structured around a number of strategic capabilities, which combine to meet a variety of client requirements. Please visit the Strategic Capabilities - Sustainability page to discover how we sustainably deliver long-term value in a fast-changing world.