Authentic responsible investing is not one size fits all
With sustainable investing attracting more investor mindshare and dollars, a growing number of asset managers are claiming to incorporate environmental, social, and governance (ESG) considerations into their investment decisions. But what exactly does that mean, and is there truly a uniform approach? The answers: it’s complicated, and no.
To start, ESG integration is far from being completely defined or—to the disappointment of many—even standardized. There are a number of organizations that purport to track and rate the effectiveness of an investment fund’s “sustainability” using a one dimensional assessment. Our experience over the years at Federated Hermes has found that a credible integration process must go beyond an ESG ranking in isolation and instead, rely heavily on stewardship—the proactive engagement by asset managers with a company’s board and management on material ESG considerations.
Put another way, investors who embark on an intentional ESG integration journey should look beyond outsourcing their research to third-party ESG data providers and adopt a proprietary view. Equipping fund managers and analysts with external ESG ratings can be a starting point. But with a deluge of ESG data offerings and a low barrier to entry, the more important questions investors should ask themselves are: how is the information useful in the investment process, and when does it make a difference to the investment case?
Identifying mispriced ESG risks and opportunities in the market necessitates a differentiated research input that’s customized to a strategy’s investment philosophy. Comprehensive incorporation of ESG information requires direct collaboration between in-house engagement experts—a resource Hermes pioneered more than 15 years ago—and the portfolio managers who put their unique ESG insights to work. As is the case with other fundamental investment criteria, financial materiality of ESG considerations and engagement objectives will vary by region, sector and industry. Given these intricacies, ESG integration will look different depending on a strategy’s security selection and portfolio construction methodologies. A quantitative approach, for example, will incorporate ESG and engagement differently than a qualitative, bottom-up approach.
We believe that investing responsibly goes beyond claiming consideration of ESG issues. It should also encompass a dedicated, tailored approach to an integration-and-stewardship strategy. Without proprietary ESG research and engagement subject-matter expertise, traditional asset managers could soon be at a disadvantage. By delving deeper than surface-level ESG considerations and going beyond widely disparate sustainability ratings, investors can seek to be authentically responsible.