The better the question
What impact does responsible investing have on alpha?
We used evidence to build a case for integrating environmental, social and governance (ESG) factors into investment decision making.
The non-executive board of a leading UK asset owner asked us to assess how the adoption of a responsible investment strategy might affect fund performance.
Asset owners and managers are currently under pressure from both regulators and customers to integrate ESG factors into their investment decision-making process. Regulation on the horizon includes the EU Action Plan on Sustainable Finance, and recommendations from the Task Force on Climate-related Financial Disclosures, which Mark Carney, the Governor of the Bank of England, wants to make mandatory.
Our client did not have an overarching responsible investment strategy, although its asset manager had already developed a number of ESG funds and products. The client wanted us to provide an objective analysis of the likely effects of developing such a strategy; to benchmark its performance against peers and identify gaps; and to recommend a route to becoming a leader in the field.
“The business was seeing a lot of market activity around ESG,” explains Simon Abrams, EY UK & Ireland ESG and EHS Transaction Support Head. “They were aware that their peers were moving on this, that regulations were coming, and that clients were increasingly asking questions. Ignoring it was not an option.”
The better the answer
Benchmarking performance and measuring potential impacts
How an extensive analysis of market data helped the firm see the full picture.
Our first task was to benchmark the business’s performance against its peers, for its key asset classes (equities, fixed income and property), so that it could take market practices into account when setting its future direction. We conducted a desk review of public disclosures from both asset owners and asset managers, to understand what activity they were engaged in and where their priorities lay. The results showed that our client was significantly behind the curve, even though its asset manager was active in ESG investing.
Next, we examined a range of funds and strategies to determine whether integrating ESG into funds would reduce investment return or increase risk. Our conclusion from the analysis was that there was no net detriment to performance; indeed, a number of reports highlighted a degree of outperformance.
“We looked at a whole range of data, both from academic studies and from market-based analyst studies by banks,” says Abrams. “It’s probably the most extensive assessment of market data that I have seen. The board found our analysis persuasive – it was very important for them to have an independent, external view that wasn’t ideologically swayed.”
Finally, we presented a maturity scale and suggested the company should aim to be in an “advanced” position within 18 months. It could then explore the business implications of moving to a “leading” position.
Based on our findings, the board was confident about moving forward. With our support, the firm’s next step is to develop a responsible investment policy, which will include areas such as its approach to climate change, how it communicates its activities and whether it integrates ESG explicitly into fund options.
The better the world works
Significant market opportunities lie ahead
The company is now poised to develop a responsible investment policy and communicate the benefits.
By taking proactive steps to integrate ESG into its processes, the business will be well placed to take advantage of significant market opportunities and create sustainable value for customers.
“ESG and long-term value are two sides of the same coin,” explains Abrams. “It means you are considering how the world is changing and how these changes will affect your business.”
As well as hard legislation and market-based guidelines coming into effect, customers are becoming increasingly outspoken on issues such as climate change, excessive use of plastics in the supply chain and modern slavery. Those companies that have a well-researched and responsible approach to these issues are poised to attract new business, enhance their corporate reputation and boost performance.
Over the past two decades, we have developed critical insights into ESG policies, based on our experience working with leading investment managers in the areas of responsible investment, reputational risk and climate-change strategy.
Abrams spent five years as a socially responsible investment analyst before joining EY, and has a thorough knowledge of the subject. Further, two members of the project team responsible for delivering the project on the ground are highly experienced in this area.
“This skillset in consultants is not that common yet,” says Abrams. “Our team’s experience as well as EY’s offering to asset managers and owners is unique in the industry. Our client had confidence that we knew what we were talking about, and were able to hold our own in debate with their non-execs, who were particularly knowledgeable. They also felt comfortable with our collaborative style.”
Like what you’ve seen? Get in touch to learn more.