Investment mandates, portfolio analytics and client reporting

Question 1

investment chain agency problems can be addressed (though not completely solved) by careful alignment and accountability:

Answer 1

Alignment should be designed so that the timeframes and structures of portfolio manager assessment and remuneration closely reflect both the performance experienced by the clients they serve and the timeframes over which they need performance to be delivered.

Accountability should mean that portfolio managers respond to the clearly expressed intentions of their clients and report as fully as required.

Question 2

assessment of fund manager’s mandate delivering

Answer 2

monitoring meetings between the client and the fund manager; and
▶ the manager’s measurement and reporting of its ESG performance.

Question 3

The Pensions and Lifetime Savings Association (PLSA) produces a Stewardship Checklist for its members, which encourages just such a development of a broader philosophical approach

3 key requirements:

Answer 3

􏰥 Be clear about how stewardship fits within their investment strategy, policy and how it helps meet their investment objectives.

Seek to ensure that fund managers and other service providers deliver effective integration
of long-term ESG factors into their investment approach.

Work with their advisers to consider the level of resource available for stewardship activities, which assets are covered and what the appropriate structure is.

Question 4

how to develop a policy and philosophy, and then how it can practically be implemented.

Answer 4

A sustainable investment strategy consists of building blocks familiar to institutional investors: a balance between risk and return and a thesis about which factors strongly influence corporate financial performance.”

Question 5

Responding to these two building blocks, McKinsey suggests that there are two fundamental questions that asset owners need to ask in developing their ESG investment philosophy:

Answer 5

1. Are ESG factors more important for risk management or value creation?
2. What ESG factors are material?

Question 6

As McKinsey indicates, there are two key questions which will frame how this is delivered in practice:

Answer 6

1. Is ESG a risk management tool or a source of investment advantage?
2. Which aspects of ESG most matter from the perspective of the asset owner?

the answer help shape the overall SAA strategic asset allocation of the asset owner

Question 7

APPLY SUSTAINABLE INVESTING PRACTICES ACROSS SIX DIMENSIONS OF THEIR INVESTMENT PROCESS AND OPERATIONS

Answer 7

inv. mandate:
• Consideration of ESG factors, including prioritisation. • Targets.

inv. beliefs and strategy:
• Rationale for ESG integration. • Material ESG factors.

inv. operations enablers:
tolls and processes:
• Negative screening.
• Positive screening.
• Pro-active engagement.

resources and organization
• ESG expertise and capabilities.
• Integration with investment teams.
• Collaborations and partnerships.

performance and management
• Review of external managers (screening and follow-up).
• Follow-up on internal managers (including incentives).

public reporting:
• Accountability.
• Transparency.

Question 8

A number of investment strategies face inherent challenges, some of which may be due to:

Answer 8

▶ the lack of ESG data within their scope; or

▶ a relative scarcity of methodologies and best practices to apply ESG integration within an asset class.

Question 9

It is in the interests of a multi-strategy investment firm that manages both fundamental and quantitative ESG strategies to highlight the fact that active ownership activities (like engagement) are more relevant to more concentrated, fundamental strategies, rather than more diverse quantitative portfolios.

Answer 9

In each case it is worth noting that the ESG market is developing very rapidly and new offerings are being brought to the market all the time, meaning that there are increasingly fewer gaps in supply.

Question 10

ESG policy needs to address the manner in which the portfolio manager:

Answer 10

▶ addresses ESG issues at portfolio reviews;
▶ establishes the rationale and methodology for ESG portfolio-level assessment;
▶ assesses exposure to ESG risk within the risk management function;
▶ determines ESG impacts to the portfolio;
▶ responds in the investment decision-making process to ESG implications; and
▶ discloses ESG exposure to the fund’s investors.

Question 11

Annual reports may include:

Answer 11

▶ ESG activities across the portfolio;
▶ frequency of engagement; and
▶ highlighted activities and their outcomes.

Portfolios with private or unlisted securities exposure may choose to report portfolio performance against key performance indicators (KPIs) over a given investment period and relative to peers.

Question 12

The International Corporate Governance Network’s (ICGN) ICGN Model Mandate Initiative: Model contract terms between asset owners and managers provides a helpful framework and proposes best practices for ESG-aware investment mandates around:

Answer 12

▶ the monitoring and use of ESG factors;
▶ the integration of ESG factors into investment decision-making;
▶ adherence to good practice around stewardship; and
▶ voting and reporting requirements.

Question 13

According to a 2016 PRI report on How asset owners can drive responsible investment, investment mandates should require investment managers to:

Answer 13

▶ Implement the asset owner’s investment beliefs and relevant investment policies.
▶ Integrate ESG issues into their:
» investment research;
» analysis; and
» decision-making processes.
▶ Invest in a manner consistent with the asset owner’s time horizons, understanding the key risks that must be managed to achieve the asset owner’s portfolio goals.
▶ Implement effective stewardship processes, including:
» engagement with companies and issuers on ESG issues; and
» for listed equities, voting all shareholdings.

▶ Engage constructively and proactively with policymakers on responsible investment and ESG-related issues. This engagement should align with the asset owner’s responsible investment and related policies.

▶ Report on the actions taken and outcomes achieved. The reporting should enable the asset owner to:
» assess the manner in which the investment manager has implemented the asset owner’s investment beliefs
and policies; and
» understand how this has affected investment performance and ESG outcomes and impacts.

▶ some active investors focus on fundamental company-specific research, while others may emphasise quant models;
▶ some will be more event-driven, while others are more focused on identifying companies with a long-term track record of delivering superior financial performance;
▶ passive investment approaches need to build ESG priorities into the design of the mandate and the way in which investment assets are selected – typically, this is either by:
» excluding certain investments (e.g. the fossil fuel sector, or particularly carbon-intensive aspects of it), or
» applying a ‘tilt’ to a broad index (so that, to pursue the climate change example, the least carbon-intensive
companies are chosen in each sector meaning that the overall portfolio has a reduced intensity).

Question 14

As a result, different managers will integrate ESG in different ways:

Answer 14

▶ as a threshold requirement before investment can be considered;
▶ as a factor that informs the valuation or provides a quant basis for adjusting (or tilting) exposures;
▶ as a risk assessment that offers a level of confidence in the valuation;
▶ as a basis for stewardship engagement; or
▶ as a combination of two or more of these methods, which is very often the case.

Question 15

ESG integration

Answer 15

Explicitly considers ESG-related factors that are material to the risk and return of the investment, alongside traditional financial factors, when making investment decisions.

Question 16

ESG integration

Answer 16

Explicitly considers ESG-related factors that are MATERIAL to the risk and return of the investment, alongside traditional financial factors, when making investment decisions.

Question 17

Best-in-class

Answer 17

Aims to invest in companies and issuers that perform better than peers on one or more performance metrics related to ESG matters.

Question 18

ESG-related thematic focus

Answer 18

Aims to invest in sectors, industries or companies that are expected to benefit from long-term macro or structural ESG-related trends.

Question 19

ESG-related thematic focus

Answer 19

Aims to invest in sectors, industries or companies that are expected to benefit from LONG-term macro or structural ESG-related trends.

Question 20

Proxy voting, engagement and stewardship

Answer 20

Uses rights and position of ownership to influence issuers’ or companies’ activities or behaviors

Question 21

the following provides a good basis for asset owners to seek to test potential service providers, and for fund managers to demonstrate the value that they can bring through their ESG work:

Answer 21

1. Understanding how the manager sees stewardship and engagement and what its main drivers for action are. This includes how consistently that philosophy is applied across asset classes and geographies.
2. Seeking confidence in the processes by which the manager’s objectives are set and progress against them is monitored.
3. Understanding how the manager allocates its engagement efforts between the different forms of engagement.

Question 22

prioritisation of engagements is a key way for fund managers to respond
to resource constraints

Answer 22

Part of a responsive fund manager’s approach to prioritisation will be to understand what are clients’ key priorities and how these might best be reflected in the fund manager’s programme of activity.

Question 23

outsourcing proxy voting

Answer 23

• a voting platform and the pipework and

- advice on how to vote

Question 24

There will typically be annual performance discussions with fund managers once appointed; however, some clients may:

Answer 24

▶ insist on more frequent dialogue or
▶ choose to send a message that they care only about the longer term by waiting longer for any such discussions.

One of the challenges for a client is always to ensure that its fund managers do not become more short-term in their approach because they are aware the client is considering performance on a regular basis.

Question 25

ESG reporting by investment managers is widespread but varies in quality of disclosure. It ranges from:

Answer 25

▶ general discussions of current debates and themes with no clear linkage to the work of the fund manager, sometimes associated with generalised aspirations or assertions; through to
▶ much more concrete discussions of the work actually done by fund managers and delivered in practice, to the shape of portfolios and change through engagement.

Question 26

Investment firms typically produce annual (and often quarterly reports) describing:

Answer 26

▶ their investment processes;
▶ the themes that they have worked on; and
▶ case studies on ESG investing or stewardship, or both.

Question 27

Investment firms that are signatories to the PRI are also required to submit an annual report on their activities. According to the PRI, the reporting process allows signatories to:

Answer 27

▶ evaluate their responsible investment progress against an industry-standard framework;
▶ receive ongoing feedback and tools for improvement;
▶ benchmark their performance against peers;
▶ see the big picture by understanding the state of the market;
▶ strengthen internal processes and build ESG capacity; and
▶ summarize activities for staff, clients, shareholders and regulators.

Question 28

In 2015, the PLSA published a disclosure guide for public equities developed by a group of pension schemes, setting out some pared down expectations for manager-reporting on both ESG integration and stewardship activities.18 The disclosure on ESG integration asks for separate disclosure on both:

Answer 28

1. identification of ESG risk; and
2. the management and monitoring of ESG risks and opportunities, with suggested possible disclosures in respect
   of each.

Question 29

The first three possible points offered as ways to demonstrate the identification of ESG risk and opportunity are:

Answer 29

1. Examples of where and why the manager is prepared to take either stock or sector ESG risks, or where it sees opportunities.
2. Quantitative or qualitative examples of material ESG factors identified in fundamental analysis and stock valuation.
3. Identification of long-term ESG secular trends and themes (as potential determinants of future growth or valuation etc.) and the extent to which they have influenced portfolio construction decisions.

Question 30

The proposed possible disclosures to demonstrate the management and monitoring of ESG risks and opportunities include:

Answer 30

▶ Stock level ESG analysis for top risk and performance detractors or contributors in the reporting period.
▶ Any material changes to portfolio companies’ ESG performance. Examples may include where the manager’s
view of ESG risk and opportunity differs from the market or rating agencies.

Question 31

Similarly, the ICGN international corporate governance network
Model Mandate requests two areas of disclosure that are ESG-specific:

Answer 31

1. The manager’s assessment of ESG risks that are embedded in the portfolio. This should include both what these risks are, and what the manager has done to identify, monitor and manage them
2. A detailed disclosure of stewardship engagement and voting activity.

Question 32

What the asset owner will want to know is whether the ESG approach is:

Answer 32

▶ genuinely aligned with the fund manager’s investment style;
▶ delivered effectively in practice; and
▶ aligned with their own investment needs and beliefs.
To guard against a fund manager selecting individual cases that put their work in the best light, some clients seek to identify outliers so that they can test whether the asserted method for ESG integration is genuinely delivered in practice, consistently across the portfolio as a whole.