As environmental, social and governance (ESG) factors gain steam among asset owners, how they incorporate ESG factors in their investment decisions is taking an increasing import. FEMM questioned several funds to better understand these asset owner’s journeys to incorporate an ESG philosophy in their portfolio’s. A consultant was also asked to provide general views. Reporter Amrita Sareen-Tak approached:
- Elizabeth Lewis, sustainable investment lead, World Resources Institute, AUM: $50 million
- Tim Brennan, treasurer, Unitarian Universalist Association, AUM: $200 million
- Elizabeth McGeveran, impact investing director, McKnight Foundation, AUM: $2.2 billion
- Amy Myers Jaffe, senior advisor, University of California, Office of the CIO of the Regents, AUM:$90 billion
- Alice DonnaSelva, consultant, Prime Buchholz, assets under advisement: $51 billion
FEMM: How did your board decide to apply ESG principles to its investment portfolio?
Lewis: The board considered a wide range of approaches to ensure that the investment strategies governing our endowment are in-line with World Resources Institute’s (WRI) programmatic expertise and values. We reviewed the best practices and research related to sustainable and ethical investment standards and considered leading guidance on the fiduciary duty of board members, such as that by the United Nations-sponsored Principles for Responsible Investing (PRI).
Brennan: The Unitarian Universalist Association (UUA) has been committed to corporate responsibility and socially responsible investing for decades. The board selected me to be treasurer partly because of my background in SRI at Ceres. My charge was to grow our SRI activities in investing, engagement, and impact investing.
McGeveran: The McKnight foundation embarked on a year-long study around impact investing with Imprint Capital and designed an approach for the foundation. This included assessing the ESG capacity of our fund managers and carving out 10% of the endowment for mission-aligned investments.
Myers Jaffe: In 2013 and 2014, students, faculty and alumni activity petitioned the board of regents to address stakeholder concerns regarding climate change and the University of California’s investments in oil, gas and coal companies. In 2014, the board approved the creation of a task force to study ESG related issues, including the creation of a sustainable investment program that could more formally integrate sustainability into the investment process.
The office took a leadership role to establish an investing framework and integration plan. A critical first step was joining the PRI, which offers peer-to-peer collaboration and best practice templates for implementing responsible frameworks. The office also sought advice from peers and experts on sustainability about best practices and research on sustainable investing and strategies. In September it published the Framework for Sustainable Investment that included input from various stakeholders.
FEMM: With which ESG issues are you most concerned?
Lewis: WRI’s programmatic expertise heavily informed which keys ESG risks to consider including water, climate, energy and land use.
Brennan: Climate change, equitable treatment of lesbian, gay, bisexual and transgendered people, lobbying and political disclosure, human rights, environmental impact.
McGeveran: Climate change, water quality of the Mississippi River, affordable housing.
Myers Jaffe: There are eight themes that the office believes are driving new economic and financial trends and can guide its investment decisions and manager selections. These include: Climate change, food and water security, inequality, aging population, diversity, human rights, circular economy, and ethics and governance.
FEMM: How do you incorporate ESG into your investment decisions?
Lewis: We first examined our listed equity portfolio and constructed a new portfolio of sustainably managed funds to replace prior ones. We then devised a method for ensuring the new investments aligned with WRI’s core mission and expertise, while also fulfilling financial requirements. Factors considered included: strength of fund managers’, ESG capacity, portfolio ESG score relative to adjusted benchmarks and the portfolio’s performance based on key MSCI ESG indicators.
We are now focused on other asset classes beyond listed equities.
Brennan: ESG issues are considered in every manager search. We favor managers who incorporate ESG/SRI strategies in their process and who are active shareholders. We accept that for some asset classes, for example hedge funds, it is difficult to find managers who incorporate ESG. We have charged our consultant with assisting us in implementing ESG strategies throughout the portfolio. This is a long-term goal. We also screen our separate accounts to exclude underperforming companies and weight the portfolio towards better ESG-focused companies.
McGeveran: We assess the ESG capacity of our fund managers, which provides new insights into the investment processes and sophistication. For the high-impact portion of our portfolio, $200 million, we can pursue opportunities in public and private markets and can utilize funds, direct investments or debt to achieve our objectives. Our goal is to find the correct balance between risk, reward and impact.
DonnaSelva: We work with our clients to categorize their assets in a manner that is consistent with the mission and availability of options is a given sector. Generally, more investment options that integrate ESG factors exist in public equity and fixed-income, followed by real assets and private equity, and then Hedge funds. It is important for investors to encourage managers to develop their knowledge and capacity for incorporating ESG factors into the investment process and expand the universe of available options.
FEMM: What portfolio changes have you made given your ESG values?
Brennan: Over half of the portfolio could be characterized as taking an ESG approach. Our large-cap value equity fund is basically a modified index fund tracking the Russell 1000 value while simultaneously weighing the portfolio towards companies with stronger ESG performance.
McGeveran: We have removed coal from two portfolios totaling 15% of the endowment and carved out 10% specifically for higher impact investments aligned with the foundation’s mission.
Myers Jaffe: The most notable change was our decision to liquidate holdings in coal mining firms and companies primarily engaged in Canadian oil sands production.
FEMM: What changes does the industry need to undergo to better facilitate ESG adoption?
Brennan: A better definition of “ESG” is needed in practice for each firm. Man have latched onto ESG and have become PRI signatories. We need a way to distinguish which managers seriously apply resources to their ESG program. Finally, we need to determine how to measure long-term performance. We talk about it, but there are not good ways to measure it.
Myers Jaffe: The fund management industry needs to embrace the benefits of ESG risk evaluation to its own products and not shift the responsibility to asset owners who may be less equipped to evaluate such risks. Investors should not have to make a “choice” between taking ESG seriously and using managers known for offering the highest returns.
DonnaSelva: Broader and more meaningful data is needed across regions to better incorporate ESG factors into investment decisions. Finance professionals need education regarding incorporating ESG factors into investment processes, the status/quality of available data, and determining whether progress toward environmental and social targets is a proxy for good governance, or does the progress in and of itself add value to a company.
The article originally appeared in Foundation & Endowment Intelligence.
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