Navigating the world of ESG is not always an easy thing for trustees. Nick Spencer looks at some of the important cross-currents they must take into account to complete their fiduciary duties.
From this October, all UK pension fund trustees will need to have a written policy on their ESG considerations. It will no longer be enough for them to simply delegate ESG responsibilities to their investment managers. They will have to demonstrate how they monitor and oversee that delegation. How will they do it? Trustees can take five steps that will help:
1. Look beyond process and marketing
Regrettably in many asset managers, the marketing department is considerably more ESG-engaged than their portfolio managers. There is far too much ESG-wash to rely on descriptions of philosophy and process. Trustees will have to dig into the managers underlying portfolios and seek specific evidence of how ESG factors are being managed in both security selection and portfolio construction.
2. Don’t rely on high or low ESG portfolio numbers
ESG portfolio scores alone don’t indicate whether or not ESG risks are being well managed. ESG scores are inconsistent between providers, and there is also a large cap bias. Some active managers will favour higher ESG scoring companies, whilst others look for improvements in lower scoring companies. So a high or low ESG score portfolio on its own doesn’t indicate the quality of the management of ESG portfolio risks.
3. Look for the changes in ESG numbers
Whilst ESG portfolio scores on their own are not meaningful, a low number in a company highlights potential ESG issues there. Looking at the quarterly changes in the portfolio scores helps identify where changes in ESG risks are being taken. It can also be helpful to identify the largest performance detractors with low ESG scores, ESG score downgrades and stocks where ESG controversies have arisen. Together these form a “map” of portfolio changes and topical ESG issues.
4. Use the changes in scores to interrogate the portfolio managers
Having identified key ESG risk changes in their portfolio, trustees can then seek evidence for the management of these risks. It is unlikely that a particular ESG factor will have been the core driver of an investment decision. But by having a dialogue with the portfolio managers around the portfolio changes and low scoring stocks, trustees can investigate the manager’s awareness and consideration of ESG risks. It quickly becomes clear which managers have fully investigated ESG risks and which are not well versed in them.
5. Report back to members
Seeking direct evidence of ESG management enables trustees to truly monitor the risks in their portfolios. These processes and the findings can also form the basis of a report to members that DC trustees will have to complete in the future.
Nick Spencer is a sustainable investment advisor at Gordian Advice.