the business case for esg in institutional investment

May 2012

The business case for ESGin institutional investmentThe RI/MSCI round table debate

Part 2: ESG: current

practices, futureprospects

Martina Macpherson, Zach Oleksiuk, Bruce Kahn, Bill Mills, Tom Kuh, Gerard van Baar, Marcel Jeucken, Mariela Vargova, Rob Lake, Roger Urwin, Erika Karp, Andreas Hoepner, Noel Friedman, John Phillips, Sarah Cleveland, Chris McKnett, Linda-Eling Lee

Roundtable Concept and Moderation:

Martina Macpherson, Vice President, MSCI & PhD Candidate, Centre for Responsible Banking & Finance (RBF), University of St Andrews

Hugh Wheelan, Managing Editor and Co-Founder, Responsible-Investor.com

The business case for ESG in institutional investment: the RI/MSCI round table debate

Part 2: ESG: current practices, future prospects? page 2

List of participants:

Martina Macpherson, Vice President, MSCI and PhD Candidate,University of St. Andrews/RBF, UK

Zach Oleksiuk, Vice President, Corporate Governance and ResponsibleInvestment, BlackRock

Bruce Kahn, Director and Senior Investment Analyst,Deutsche Asset Management

Bill Mills, Managing Partner, Highland Good Steward Management

Gerard van Baar, Managing Director, Centre for Climate & Sustainability,Holland Financial Centre

Marcel Jeucken, Head of Responsible Investment, PGGM Investments

Mariela Vargova, Senior Sustainability Analyst, Socially ResponsiveInvestments, Rockefeller Financial

Rob Lake, Director of Strategic Development, United Nations Principles for Responsible Investment

Roger Urwin, Global Head of Investment Content, Towers Watson

Erika Karp, Global Head of Sector Research, UBS

Andreas Hoepner, Lecturer in Banking & Finance, School ofManagement, University of St. Andrews

Noel Friedman, Head of Business Development, MSCI ESG Research

John Phillips, Senior Portfolio Manager, Chairman of RI Committee,AllianceBernstein

Sarah Cleveland, Founder & CEO, Sarah Cleveland Consulting

Chris McKnett, Vice President, Head of ESG, State Street Global Advisors

Tom Kuh, Executive Director, MSCI ESG Research

Linda-Eling Lee, Executive Director, Global Head of ESG RatingsResearch, MSCI



Marcel Jeucken: On the materialityside, PGGM started this journey in2005 by laying down five investmentbeliefs. One is that “responsibleinvestment pays off,” but that it worksdifferently in the short and long termand across different asset classes indifferent ways, of course. In the shortterm if information is not material, say inequity portfolios, you don’t integrate itinto investment decisions, but you keepan eye on it. If your investment horizonis longer, say in real estate, privateequity or infrastructure, where youmight invest for 10 to 15 years, thenyou have to understand what the worldis going to look like. i.e. how

governments and businesses are goingto respond to society’s needs, andhow customers are going to react. Takereal estate, you have to make sure yourbuildings meet environmentalstandards to be able to sell them. Thatcan be costly, and its something youshould look at when you buy anddevelop property.

Asset owners have got liabilities for 50,60, 70 years so they have tounderstand what the world is going tolook like in the future, which alsomeans understanding their own role asan influential group of asset ownersthat can help frame the world for

sustainable finance. This is a muchbigger question of universal ownership(owning the whole market) with long-term liabilities.

Hugh Wheelan: Zach and John, I’dlike to bring you in. How do theseissues resonate at large fund managerslike BlackRock and AllianceBernstein?

John Phillips: AllianceBernstein is amainstream investment manager so wehave a fiduciary responsibility tomaximize returns. We recognize thatESG issues can have an impact oninvestment returns. We are a recentsigner of the UNPRI, as of November

Hugh Wheelan: I’d like to start by asking some of the asset managers how they have developed theirESG strategies internally?

Responsible investment . . . worksdifferently in the short

and long term and acrossdifferent asset classes



1st, 2011. What I’ve done over the lastcouple of months, and will continue todo, is meet with our 20+ investmentteams across equities, fixed income,and alternatives. I’ve sought to makeclear to them the commitment that theyhave, as a result of the firm’scommitment, to actually make this areality in their day-to-day investmentresearch and decisions. Our approachis to integrate ESG so that it is the roleof hundreds of people, because wehave many analysts, portfoliomanagers, and CIOs. The goal is tointegrate ESG within investmentresearch and decision-making andhave the investment teams providetheir own examples.

Hugh Wheelan: How hard is this forasset managers who are held to short-term performance to integrate ESG intostock selection decisions? It’s taken acertain amount of time for some bigmanagers to sign the PRI. Are theyserious, or are they just seeing the waythe client wind is blowing?

Martina Macpherson: There has longbeen a debate between those whoregard ESG factors as being risk factorswhich can have a material impact oninvestment performance - and thosewho regard them as exclusive socialissues. However, the evidence ofmateriality of ESG factors is now reallybeginning to take shape as practitionersare mandating and integrating ESG -and excellent academic research hasemerged in this field.However, material ESG issues vary by

industry sector. This is because theimpacts that companies have areassociated with the type of industryactivity and their core business models.All businesses use resources and haveenvironmental and social impacts—thetranslation of those impacts into industryspecific terms is what makes themuseful, actionable and measurable, bycompanies and by investors.Understanding the relevant sustainabilityissues by industry provides a way tobenchmark performance of investmentsand also provides a constructiveplatform for dialogue with portfoliocompanies. Improving performance onkey ESG issues can help to mitigate riskand unlock value for shareholders.Hence, it is a component of fiduciaryduty to understand and evaluatematerial ESG risks and opportunities foreach industry and asset class.Looking at ‘materiality’, we could thenalso include the following question:- Can ESG factors make a materialdifference to the risk/return profile ofportfolios - and how?

John Phillips: There are so manyinvestment time horizons for investorsand managers. The UNPRI does askfor increasingly rigorous reporting, soit’s in the best interests of signers to bevery serious about their responsibilities.In the case of a passive equitiesmanager, I think the ESG obligationcould be fulfilled within appropriateproxy voting. Considerations of ESG instock selection do not apply, unlessthey are using investment restrictions. I

agree that for a very short-terminvestor, ESG considerations could playa smaller role. A purely quant or apurely passive manager may not havedeveloped their own proxy votingresources and may be more likely torely on a proxy voting service. From thepoint of a fundamentally oriented firm, Ithink it is intuitive and common senseto take a long-term view though.

Zach Oleksiuk: We believe that goodgovernance and good stewardship ofassets can contribute to long-termvalue, and we have a fiduciary duty toact in our clients’ interests at all times.The most common engagement activitythat our team conducts is still proxy

Good governance and good stewardship

of assets can contribute to

long-term value



voting, which we supplement in manycases with ongoing discussions withcompanies aimed at building mutualunderstanding. The alternative is tobuild out your in-house specialist groupfor proxy voting and engagement,which, by the way, we do on behalf ofour large set of index funds.

Our engagement activities are meant toshare our ideas, and to understandwhere companies are coming from,and to effect change if we think thatthere is a problem. A lot of companiesare, frankly, surprised to hear thatBlackRock cares about a certainsupply chain issue. They might see it asa social issue while we see it as aneconomic issue.

Sarah Cleveland: The differencesbetween shareholders are major. In myexperience as an investmentconsultant, working with smallerinvestors, say $100 million and even to

multi-billion dollar funds, the investmentcommittees have little clue what’s in theportfolio. The consultant shows themthe top 10 stocks, and there isn’t anydiscussion about the companies;whether it’s a passive or active portfolio,it’s pretty much the same. However,I’ve just started as an investmentcommittee member for a private familyfoundation and I’m sitting on the otherside of the table, so to speak. Theyhave an environmental mission and theywant to do more ESG integration andreally look at their investments. But, Iwas struck at my first committeemeeting, that there was absolutely noinformation on the managers. I was justgiven a list of products. We can’tunderestimate the basics that we needto get under our belts as well.

Some asset owners are just totallyoverwhelmed by this stuff and notequipped at all. They don’t know whereto begin, especially when theirconsultant has never really addressedmany of these issues.

Rob Lake: I’d like to ask the assetmanagers around the table, what kindsof signals and messages they aregetting from clients? Is there actuallydetectible client pressure?

Chris McKnett: From clients in theNetherlands it’s been an area oflongstanding interest, and in Australiaalso. US clients have become muchmore aware of the issues, but they arelargely agnostic.

Erika Karp: I actually think some of themost brilliant investors in the worldalready are doing this. I think there aremassive numbers of closetedsustainability investors out there. Theydon’t talk about it. They may simply notbe labeling it this way. And they may notbe doing it systematically. But there areinvestors out-performing even intoday’s markets where you have anunprecedented correlation in assetsand I think some are pursuing ESGstrategies. Some are consciously notusing the terminology because theydon’t want to be pigeonholed.

Linda-Eling Lee: I think a lot of peopleare already doing some form of ESGrisk analysis in private equity. It’s partlybecause of the level of due diligencethat you’re able to perform on a singlecompany. Coming back to the questionof materiality, one thing I wanted to addis that whenever there is someregulation or policy change beingdiscussed, something will likely happendown the road, we just don’t knowwhen. You don’t need to have aposition, for example, on hydraulicfracturing to know that there will bemore regulation somewhere down the

I think a lot of people are already doing some

form of ESG risk analysisin private equity



road, which will directly impactoperational costs and could generatemajor liabilities. We may not have thespecific timeframe for it, and we don’tknow the exact size of that future costjust yet, but that does not matter forunderstanding that some companiesare better positioned for those eventualdownsides than others.

Hugh Wheelan: Is the business modelviable enough to be able to invest inbetter research?

Linda-Eling Lee: Part of the problem, Ithink, is that a lot of the research inmainstream financial analysis starts bylooking at industry drivers and then triesto figure out whether or not acompany’s business model is going towin or lose based on those drivers. Incontrast, a lot of ESG analysis looks at

specific ESG factors and assumes thata specific factor matters for allcompanies across the board. I think thisdiscrepancy between the twoapproaches raises the barrier tointegrating ESG research. I think it’smuch easier for investors and analysts ifESG research can be more integratedinto the way investment processesalready currently exist, i.e. to start at theindustry level and then to look atspecific drivers of industry risk andreturns. Then add the extra layer oflonger-term, potential problems thesecompanies could face if they’re not ableto anticipate and manage these risks.

Erika Karp: Hugh, you asked aboutthe business model. As has beensuggested, I think partnering withanalysts and portfolio managers toelevate their knowledge on ESGissues, change their lens and get themto ask different questions on thecompanies and industries wherethey’re so expert already, is the waythat real change will happen.

Rob Lake: Or, is the reality, Erika, thatfund managers get rid of the SRI team,take on an external ESG researchprovider and then hand it over to acouple of portfolio managers and say:“That’s ESG integration for you.” Theanalogy that I always use when thisissue comes up is that we still have,well most investment institutions stillhave, a team of economists, or peoplewhose job title includes ‘economist’.Which doesn’t mean that you don’texpect your in-house portfoliomanagers and analysts to know a littlebit about economics on a good day.So, there’s probably a place forsomeone who knows more about theissues in the institution than everybodyelse. But clearly more people infinancial firms need to know more thanthey currently do. So, huge, centralizedESG teams are probably not the way to

It’s much easier forinvestors and analysts if

ESG research can bemore integrated into the

way investmentprocesses already

currently exist



go. But an elite cadre of specialistsspreading their tentacles throughoutthe shop as John seems to be doingsounds pretty sensible.

Chris McKnett: Rob you asked aboutclient signals earlier. One thing we clearlysee at SSgA is good breadth to currentmarket signals across client segmentsand across markets. But within thosemarkets and within those clientsegments, there’s not a lot of depth. It’stop-heavy, meaning that you’ve got bigactors who are very influential, and thena very long tail on the left-hand side

that’s not doing much. The signals arecoming through in the aggregate, butthey don’t weave together into a veryclear narrative. But, directionally, it’s veryclear to us where this is heading. If youthink about ESG demands andpressures from asset owners andconsultants on us as a manager andyou chart it, it’s moving up and to theright very steadily. We, and a lot of themarket like to think of ESG andsustainability as a product approach: i.e.you build something, you think it works,you put it into a strategy, you sell it. Thatcan still be done. But what I refer to asthe inconvenient truth of ESG, is that thepressure is on us to come up with asystematic way to integrate ESG factorsinto our investment decision-makingand stewardship of assets. The reasonit’s inconvenient is that it’s more aboutrevenue retention, rather than amonetized investment strategy. Andthat’s a long build-up for a $1.8 trillionmanager with a quant and beta focus,because it requires a combination ofinternal and externally sourcedinformation and data.

Hugh Wheelan: I’d like to ask ourpanelists to reflect on the discussionthey’ve heard and start looking ahead abit to what the future might hold, sayout to 2015? Roger, could you give usyour thoughts about what you’veheard?

Roger Urwin: The paradox to me isthat very few asset owners andinvestment board members andtrustees could stay with thisconversation. It really has profoundsignificance, is financially driven and issignificantly material. But, the way thatwe actually run the investment chain isthe convenient – Plan A - way, viabenchmarks and one-year plans ofthinking these issues through. Inaddition, many asset owners arecurrently beset with solvency pressuresand so they’re quite comfortablethinking with a Plan A, which assumesbusiness as usual, which is investmentand monitoring against a one-year timeframe. But there is a Plan B, which isdoing two things well: the present andthe anticipation of the future. This is the

idea that we should be investing asthough we understand and make someallowance for the transformations thatare likely in the future. We should bemindful of all those new pricesmaterializing in tomorrow’s economy;of externalities becoming internalizedcosts. Those are the sorts of issueswhere asset owners are not getting amandate through to the assetmanagers. As a result, in myobservation, the reaction of asset

The pressure is on us to come up

with a systematic way to integrate ESG factors into our investment

decision-making



managers and PRI signatories, isactually: “fine principles but show methe action.” It isn’t so obvious to manypeople that ESG is a material influenceand the experts in this room aren’tnecessarily getting their influencethrough to the whole investmentprocess. Currently, the relationshipbetween portfolio managers andexperts in sustainability is limited andnot well integrated. That said, I do think

there is a fantastically upbeat part ofthe conversation. The trajectory ofchange I experience most of the time isactually relatively flat. But there aresome leading funds that are universalowners, i.e. big investors that own aslice of everything in the market, whoare starting to articulate investmentstrategies that are to do with capitalbeing applied in a different, moresustainable, long-term manner. Thiscould become self-fulfilling and knockon into prices when more asset ownersgenuinely attempt to do integratedESG. This will only come about withbetter measurement. The merits ofintegrated ESG are very difficult tomeasure. And when things are notmeasured, they don’t get respect.

Bill Mills: I think if we’re truly going tomove into long-term investment thencorporate engagement is going tobecome massively important. We needthe ability to lay out a corporateengagement plan and convey that tofiduciaries in an easy, understandablefashion, with benchmarks and hurdles.If you’re a long-term investor in acorporation, and you’re engaging with

the corporation’s management youought to have confidence in the DNA ofthat corporation. And you ought to beable to explain those things tofiduciaries much easier than by talkingabout ineffective Sharpe Ratios… nodisrespect.

John Phillips: I wanted to saysomething about corporationsthemselves. We’ve talked about assetowners and investment managers. Butas someone who’s engaged with manycorporations, I know there’s a vastdifference in the ability of corporationsto engage. The really interesting recentHBS paper referred to earlier by Ecclesand Serafeim found that only half of the90 most sustainably orientedcompanies in the US, by their definition,had a board-level commitment tosustainability, and only a third of those90 companies had clear links betweensustainability and senior executivecompensation. So, we are in a verynascent stage with regard to corporatesustainability. But I think that willimprove rapidly, and I think that thecompanies that are greenwashing willclearly be discovered. We also need tomove toward some kind of ‘sustainability assurance’ as well. Wedon’t yet have accounting standards oraudits for sustainability, but severalgroups are working to develop them.

ESG is a materialinfluence and the

experts in this room aren’t necessarily

getting their influencethrough to the wholeinvestment process



Tom Kuh: I think that to get the kindsof standards you’re talking about in anindustry that really is in development,there needs to be policy in place thatmandates the reporting of informationthat analysts can then use. We’ll knowwe’ve done our jobs when thedistinction between ESG andmainstream financial research ismeaningless; when the standard forgood financial analysis involves, at avery fundamental level, integration ofESG factors. The step preceding that isgoing to be the standardization of theinformation used, so that you getmeaningful, comparable informationinto analysts’ hands.

Rob Lake: What I hope we’ll see by2015 is stronger, more sophisticatedand penetrating signals coming downthrough the investment chain. Don’tmisinterpret what I’m about to say, but Ialso hope people will move beyondsimply asking their asset managers

whether they are PRI signatories, toasking slightly more probing,meaningful and enlightening questionsabout the nature of the investmentprocesses that the managers aspire torun for them. I also hope investors willstart to incorporate the basic questionsthat tend not to get asked at themoment on stock examples: Forexample: “Talk me through yourinvestment positioning at the time ofthe Gulf of Mexico explosion.” Or:“How can you explain your overweightin BP at the time?” Hopefully we’ll alsosee more questions being asked aboutthings like portfolio turnover and itsmeaning in the context of long-termvisions and views. Maybe we will alsosee long-term training as part of themission of asset owners, which is thenreflected in the way they look at otherasset classes like hedge funds, quantstrategies and high-frequency trading.What can corporations realistically do inresponse to enlightened long-terminvestors if the short-term investmentscoming from the overwhelming bulk ofthe market are pushing in the opposite

direction? Companies see their shareregister changing all the time and hearpeople saying “Short-term, short-term,short-term” on profits. Then they havea small number of people coming tothem saying: “Well, I’ve got thismandate from these enlightened assetowners telling me that I should tell youto be long-term.” However, from the

broader perspective of a healthy,functioning economy with corporationsthat deliver financial returns in the long-term that long-term asset ownersneed, we’ve got to think through theseissues.

Companies see theirshare register changing

all the time and hearpeople saying “Short-

term, short-term, short-term” on profits

We’ll know we’ve doneour jobs when the

distinction between ESG and mainstreamfinancial research is

meaningless



Andreas Hoepner: It’s quiteinteresting to see how conventionalfinance deals with predictions. Fewpeople predicted Twitter or the ArabSpring, and when you look back,predictions seem, on average, to begetting worse by the year because theworld’s getting more complex andmuch quicker. Within weeks now, youcan have a serious problem onFacebook because millions of peopledon’t like you. Twitter is quicker thanany conventional journalist in manycases because it’s a direct source tothe consumer. So there are manyintangibles coming to market.Therefore, I would presume there’s alot of opportunity for certain types ofESG investment.

Sarah Cleveland: One commentabout asset owners. I don’t seecorporate pension plans in the UStaking this up by 2015. I think there is asignificant move, however, on thefoundation side and amongst high-net-worth and family offices. There’s a lotof interest in impact investing, andunderstanding what’s in your portfolio.

When you look back,predictions seem, onaverage, to be getting

worse by the year

There’s a lot of interest in impact investing, and understanding

what’s in your portfolio

the business case for esg in institutional investment

Documents