More than 90 per cent of global public investors have specific environmental, social and governance investment policies in place or are in the process of developing them, according to a new report by BNY Mellon and the Official Monetary and Financial Institutions Forum.
The report combines the results of two separate surveys, with respondents to the first including 17 global pension funds, 11 sovereign funds and 50 central banks and respondents to the second including 27 pension and sovereign funds.
Motivations for implementing ESG policies included the expectation of superior risk-adjusted returns and the need to align investment strategies with organizational values or minimize reputational risks. However, respondents said they struggle to formally measure the impact and non-financial performance of investment decisions, even though many said they aim to do so in future.
Some 81 per cent of pension funds said they apply exclusion or negative screening strategies compared to 58 per cent of sovereign funds and 28 per cent of central banks. The sectors most frequently excluded are tobacco, arms and coal, while a minority of investors said they exclude oil and gas, though only partially.
Among pension funds, 93 per cent of respondents said they integrate ESG criteria across an entire portfolio compared to 50 per cent of sovereign funds. As well, sustainable assets are widespread among pension funds, with 62 per cent of respondents saying they invest in them, compared to only eight per cent of sovereign funds. Thematic and impact investment strategies are well-established among pension funds, but less so among sovereign funds and central banks.
When respondents were asked about the financial impact of ESG integration, they were split between those that have seen a positive financial impact and those that claim it’s too early to tell. However, none have seen a negative impact or no impact at all. When discussing the barriers to scaling up investment, a minority (19 per cent of pension funds and 45 per cent of sovereign funds) said they fear it would hurt financial performance.
There’s also a question of measurement ability, given constrained resources and data frameworks, according to the report. Some 80 per cent of pension funds and almost two-thirds of sovereign funds identified insufficient data as a barrier to further integration.
In addition, the report noted the data required to successfully integrate the elements across E, S and G in the investment process are still at a relatively early stage and approaches to determining what constitutes material ESG information vary.
Some approaches, such as the Sustainability Accounting Standards Board and the task force for climate-related financial disclosures, favour financial materiality criteria (how ESG themes affect companies), while others, such as the Global Reporting Initiative, have a wider focus, including what matters to society more broadly (how companies affect ESG themes).
As well, ESG scoring is often facilitated by specialist data vendors such as Bloomberg, MSCI Inc. and Sustainalytics, said the report, noting each tends to employ its own proprietary assessments, methodologies and metrics, which can result in divergent measurements of the same concept for the same company, depending on which framework is used.
The majority of survey respondents said they don’t use ESG benchmarks or ratings indexes for their investments. Among those that do, most use their own benchmarks and only around half said they incorporate quantitative ESG data in their investment process.
According to the report, optimizing ESG investment practices will be a multi-stakeholder process that institutional investors will play a key role in advancing. It noted four trends that will shape global public investors’ ESG investment strategies.
First, progress on mandatory and principles-based ESG regulations, combined with advances in data capture and remote sensor technologies, will add more breadth and depth to primary data and corporate disclosures on material issues.
Second, improvement in data analytics, such as artificial intelligence, machine learning and sentiment analysis, will enable more accurate pattern- and sense-making from combining financial and ESG data. This will enable more granular attribution of ESG impact to specific companies and assets and facilitate actionable investment decision-making.
Third, to truly leverage these two trends, investment and human resources teams within global public investors will have to prioritize developing the human capital and technical capacity to blend financial and alternative data sets.
And finally, in the medium to long term, ESG investment stands to benefit from the movement toward understanding and using ESG data as a public good. The report suggested global investors should be a part of this, noting comprehensive, widely-available data will promote more accessibility and greater liquidity from increased participation in sustainable asset markets.