Driven by clients and missions that align with sustainable outcomes, incorporating the guiding principles of environmental, social and governance (ESG) into their portfolios is a high priority for asset managers, according to new research.
Compiled from interviews conducted in the third quarter of 2021 with 20 institutional asset owners and asset managers, the research issued by Cerulli Associates and sponsored by Russell Investments found that, while asset owners exhibited varying levels of adoption, asset managers had more universally established climate investing as an initiative.
While asset managers told Cerulli that their adoption of sustainable investing capabilities is primarily driven by external client demand, internal values reportedly are the key driving force behind asset owners’ adoption of environmental metric considerations. “As the asset management industry is increasingly competitive and firms are constantly searching for a competitive edge over passive, managers have devoted significant resources toward combating the climate crisis,” the report notes.
Proprietary Research
Leveraging their size and resources, many asset managers have built proprietary research platforms in efforts to service multiple clients with different climate objectives. As such, asset managers are increasingly devoting resources to ESG, either by establishing ESG specialists or heads of ESG to assist in developing frameworks and ultimately integrating ESG policies into their overall investment approach.
“Nearly all managers who participated in the research reported having proprietary research efforts on climate investing, often housed within a dedicated team. Others report incorporating climate metrics into capital market assumptions or actively researching transition and physical risks, often looking at various scenarios and their implications for portfolios,” notes James Tamposi, Senior Analyst at Cerulli.
Strategic Partners
The report further observes that integrating a climate investing approach is seldom done in isolation. Asset owners tend to partner with asset managers or intermediaries (consultants or OCIOs) to provide guidance, while asset managers generally begin by responding to ad hoc client requests, with a full-fledged process often involving partnering with a third-party data provider or specialist.
“Intermediaries play a pivotal role in the integration of ESG factors. Investment consultants are charged with helping asset owners implement ESG considerations and opportunities and regularly collaborate with their asset owner clients,” Tamposi notes. In supporting this, Cerulli notes that research from its 2020 survey of OCIO providers found that 87% had resources dedicated to ESG incorporation and 97% considered ESG factors when conducting manager due diligence.
Cerulli further observes that asset owners interviewed for the report are increasingly influencing the companies in which they invest by working with their asset manager partners to align their proxy votes with their organization’s values and principals.
According to the research, several asset owners have sought to use their investment portfolios to offset their carbon footprints by investing in technologies like carbon recapture. In response, asset managers are incorporating more environmental themes into their ESG process with climate change/carbon (90%), energy efficiency (85%) and pollution (79%) cited as their top priorities.
Barriers to Adoption
Not surprisingly, discrepancies in levels of adoption from asset owners generally correlated with institution type. Cerulli notes that, while most nonprofits have taken measures to incorporate climate metrics in their investment processes, fewer corporate retirement plans employed measures.
Corporate plan sponsors cite various barriers preventing them from moving ahead with climate investing, including the Department of Labor’s guidance on pecuniary factors. According to the report, plan sponsors say that they have not integrated climate considerations because they fear going against DOL guidance.
A plan sponsor quoted in the report suggested that, until new guidance is put forth, it will refrain from making any drastic changes (note that the DOL issued proposed guidance shortly after the interviews were conducted). A similar sentiment was expressed by an asset owner on the 401(k) side in terms of waiting to see where the new guidance ends up.
However, findings from Cerulli’s “U.S. Defined Contribution Distribution 2021” report show that 65% of retirement specialist advisors believe ESG products will gain broader adoption in the DC market in the coming years. This report notes that several target date fund managers indicate they play to incorporate ESG principles into their investment process moving forward. In addition, many DC-focused asset managers run ESG screens on their investment products and third-party subadvisors regardless of whether their investment product is ESG-branded, the report further observes.
Conflicting Data
Meanwhile, both asset owners and managers say they are challenged by multiple sources of conflicting data and gaps in available data. According to the report, they struggle with sourcing, aggregating and interpreting data from various climate data providers. And further amplifying the struggle is that reporting standards vary between regions and investments (i.e., public vs. private).
“It is perhaps the most critical challenge facing the industry,” says Tamposi. “Data sourcing, compounded by a lack of reporting disclosures, makes it especially difficult for investors looking to build a framework, particularly for U.S. holdings,” he adds. As asset owners and managers continue to streamline their processes, they are likely asking U.S. companies for the same metrics European companies are required to disclose, providing an avenue for global standardization, the report observes.
