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Transitioning Portfolios to Truly Sustainable Investments

Sustainability - The only season!

The investment climate is currently awash with fund launches flying the ESG banner, some new and some transitioning from traditional funds. A common problem, both for portfolio construction and fund selection processes, is the lack of the data. At Devlin Mambo we have been researching ESG portfolio data issues; in this article we share our views on where we see opportunities, and set out various steps that firms may consider to enhance ESG integration into the investment process.

Traditional funds were launched with a variety of objectives – income, growth, capital protection, to name a few. On top of these, fund managers have increasingly been embedding shareholder stewardship and an ever wider array of ESG aspects concerning the companies they invest in.

In order to explore in more detail the industry’s approach to managing sustainability risk, we ask three questions:

  1. Is the investment decision purely Profit &Loss focussed?
  2. What is limiting fund managers to a holistic view of sustainability risks?
  3. Is it possible to maintain current portfolios and transition them to a higher sustainability standing?

Although the answers to these questions are straight forward, the solutions will take time and effort to put into effect.

Turning to our first question, “Is the investment decision purely focussed on the P&L?”, in the past, we regarded fund managers as purely profit hunters, trusting them to make good judgement in their pursuits to grow our investments. More recently, the growth of ethical, then impact and sustainable funds has complicated the issue. The challenge to a pure focus on P&L is externalities. By not understanding or including correctly the investments’ underlying environmental and social factors, what may be a good investment today can become a bad long-term investment. An obvious example would be a highly profitable shoe manufacturing firm, using child labour and dumping waste into a river, which could very quickly be out of business once this is publicised and its customers rebel!

It is easy to state how important it is to factor in ESG considerations when making investment decisions. This is the case whether there is a strong appetite from clients for products that bear a ‘responsible investing’ badge, or more traditional products which monitor ESG attributes and manage them through active corporate engagement. The obvious challenge here is data - identifying, monitoring and harvesting trustworthy company level ESG data to enable managers to deliver effective stewardship.

Our second question is “What is limiting fund managers to a holistic view of sustainability risks?”. The answer is data availability and the disparate nature of that data. This has made it a seemingly impossible task to harvest this vital resource. There are a multitude of data sources involved in creating a full ESG portfolio analytics capability; just a few examples would include firms providing data on diversity, carbon screening, controversies analysis, and traditional governance reporting. In many cases, these services are provided by niche providers focussing on a specific area. Fund managers will have to form business relationships with a wide variety of companies providing multiple services across a wide variety of asset classes and geographies.

Thankfully, we are starting to see partnerships being formed. Mergers between data source firms and portfolio analytic firms will assist in streamlining the data provision for asset managers. This will not immediately solve the disparate nature of data from different providers, however, as they apply different methodologies. It will be some time before the regulators or the accountancy professions standardise non-financial reporting requirements for firms. Apples and pears comparisons will sadly be a feature for several years.

In the interim it will be worthwhile for managers to start investigating who can efficiently provide them with ESG data solutions, to enable them to monitor and manage sustainability risk efficiently and to understand the methodologies applied. Managers will also have to think of their long-term infrastructure requirements to support ESG data analytics, reporting and compliance monitoring.

And now to our third and final question, “Is it possible to maintain current portfolios and transition them to a higher sustainability standing?”. My answer is very much yes! Firms are understandably seeking to demonstrate how they are factoring ESG into their investment decision making. Both market competition and client demand mean it is paramount that firms set out clear strategies on how they intend on further integrating ESG factors into decision making, and demonstrating a defined roadmap on how this will be achieved over time. This is not an overnight event!

Connecting with your clients on this important topic, and providing them with a tangible understanding of how your stewardship will assist in transforming companies you invest, spurring them on to achieve an optimal ESG standing, will greatly strengthen your client relationships and build trust in your investment approach. After all, clients are increasingly sensitive to environmental and social issues, which has led to significant inflows towards sustainable products, often thematic by design. This is why we believe that traditional funds offer great sustainability potential, whilst their transition to a higher level of sustainability needs to be tracked and communicated to clients throughout the journey.

A key ingredient to client engagement will be sharing information to support the assertions being made about ESG progress. Not only will it be necessary for firms to collect and analyse ESG data on the companies they invest in. Firms should also be thinking how they can provide their clients with easy to access, rapid and transparent ESG portfolio reporting that demonstrates how firms are managing and monitoring sustainability risk.

Attitudes towards sustainability are changing rapidly, meaning that incorporating a culture of sustainability at company level is becoming essential, let alone the dangers of avoiding unintentional greenwashing. A common denominator in my analysis of these key questions is ‘data’.  The challenge stems from data being disparate, not standardised and not readily available in the manner desired. In addition, firms will need to create processes which can consume data from multiple sources to achieve full ESG portfolio analytical capabilities.

Our team at Devlin Mambo have been speaking to many managers so that we can understand what ESG data matters the most and what limitations the industry is experiencing with current data sources. Our team has also been busy researching dynamics and capabilities in the ESG data sources market so we are well informed on major and boutique data providers, their value chains, and how they may fit your requirements.

For more information on our ESG research and data analytics insights and specific recommendations, please feel to contact Simba Mamboininga directly, or speak to your Devlin Mambo relationship contact.

About the author

Simba Mamboininga

Managing Partner

Delivering a 360° service to the asset management industry

Devlin Mambo

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