Investment mandates, portfolio analytics and client reporting Flashcards
investment chain agency problems can be addressed (though not completely solved) by careful alignment and accountability:
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.
assessment of fund manager’s mandate delivering
monitoring meetings between the client and the fund manager; and
▶ the manager’s measurement and reporting of its ESG performance.
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:
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.
how to develop a policy and philosophy, and then how it can practically be implemented.
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.”
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:
- Are ESG factors more important for risk management or value creation?
- What ESG factors are material?
As McKinsey indicates, there are two key questions which will frame how this is delivered in practice:
- Is ESG a risk management tool or a source of investment advantage?
- 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
APPLY SUSTAINABLE INVESTING PRACTICES ACROSS SIX DIMENSIONS OF THEIR INVESTMENT PROCESS AND OPERATIONS
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.
A number of investment strategies face inherent challenges, some of which may be due to:
▶ 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.
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.
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.
ESG policy needs to address the manner in which the portfolio manager:
▶ 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.
Annual reports may include:
▶ 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.
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:
▶ 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.
According to a 2016 PRI report on How asset owners can drive responsible investment, investment mandates should require investment managers to:
▶ 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).
As a result, different managers will integrate ESG in different ways:
▶ 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.
ESG integration
Explicitly considers ESG-related factors that are material to the risk and return of the investment, alongside traditional financial factors, when making investment decisions.
ESG integration
Explicitly considers ESG-related factors that are MATERIAL to the risk and return of the investment, alongside traditional financial factors, when making investment decisions.
Best-in-class
Aims to invest in companies and issuers that perform better than peers on one or more performance metrics related to ESG matters.
ESG-related thematic focus
Aims to invest in sectors, industries or companies that are expected to benefit from long-term macro or structural ESG-related trends.
ESG-related thematic focus
Aims to invest in sectors, industries or companies that are expected to benefit from LONG-term macro or structural ESG-related trends.
Proxy voting, engagement and stewardship
Uses rights and position of ownership to influence issuers’ or companies’ activities or behaviors
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:
- 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.
- Seeking confidence in the processes by which the manager’s objectives are set and progress against them is monitored.
- Understanding how the manager allocates its engagement efforts between the different forms of engagement.
prioritisation of engagements is a key way for fund managers to respond
to resource constraints
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.
outsourcing proxy voting
- a voting platform and the pipework and
- advice on how to vote
There will typically be annual performance discussions with fund managers once appointed; however, some clients may:
▶ 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.
