Practical analysis for investment professionals
05 September 2019

The Seven Asset Owner Approaches to ESG

What role do asset owners have to play in environmental, social, and governance (ESG) investing?

Quite a big one. And as ESG investing continues to rise in popularity and prominence, the size and influence of that role will only increase.

Indeed, spread across seven asset owner types, institutional investors are a force to be reckoned with. They control over $85 trillion in assets under management (AUM) — more money than the aggregate GDP of the United States, China, Japan, Germany, the United Kingdom, India, France, Brazil, and Canada combined.

And these asset owners have already demonstrated, in both word and deed, that they care about ESG considerations and have made addressing them a priority. The CFA Society of New York’s 2018 ESG Summit made this especially clear. The dialogue, led by Hiro Mizuno, CIO of Japan’s Government Pension Investment Fund (GPIF), the largest pension fund in the world, and Dave Jones, the former California Insurance Commissioner, among other industry leaders, offered insights into how asset owners approach ESG issues and integrate ESG criteria into their investing plans.

Representatives from over 70 fiduciary asset-owning institutions across every asset owner type will again explore their ESG strategies at the 2nd Annual Climate and ESG Asset Owner Summit in New York on September 23–24, the latest Asset Owner Series™ (AOS) event organized by CFA Society New York, in partnership with the United Nations–supported Principles for Responsible Investment (PRI), and facilitated by hundreds of committed CFA Institute member volunteers around the world. Upon the conclusion of the Summit, the AOS will have featured fiduciary asset owner and institutional investment consultant speakers from organizations that cumulatively oversee in excess of $72 trillion of assets under ownership or advisory.

Ahead of the forum, we thought it’d be helpful to provide our analysis of the various forms ESG investing takes, addressing both their strengths and shortfalls as well as the positive changes they have brought about in the markets and across the globe.

1. Negative Screening

Negative screening is the most well-known and perhaps the most common ESG strategy.

It’s a pretty simple concept: If a firm’s or industry’s practices run counter to your values, you screen it out of your investment portfolio. It’s like a boycott, but with investment capital. And history shows it can exert an influence and help change things for the better. In the 1970s, for example, companies withdrew investments in South Africa in order to fight the Apartheid regime and played a role in its eventual demise.

Of course, as AQR’s CEO Clifford Asness and others have noted, negative screening does not necessarily generate superior returns. But the profit motive isn’t the only motive. Asset owners — like all of us — have goals that extend beyond the bottom line, and many would trade a few extra basis points (bps) for a smaller carbon footprint or other ESG-associated benefit.

Indeed, since they are accountable to their communities and seek to reflect the values of those communities, asset owners will continue to screen out companies and sectors that don’t align with their evolving standards. As an example, the world’s largest sovereign wealth fund, Norges Bank Investment Management, divested from tobacco producers, among other businesses, by act of the Norwegian parliament. The trustees of New York City’s $200-billion pension system have also set a goal of divesting from fossil fuels within five years.

As with doctors and their Hippocratic Oath, asset owners have shown with negative screening that their first priority is to do no harm,

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2. Climate Change

It is impossible to talk about ESG investing today without addressing the elephant in the room: climate change. The phenomenon is the primary ESG challenge and the space’s top priority, according to the PRI.

Of course, such a nuanced and complicated dilemma is not easily solved, and there is no one rubric that asset owners have embraced to counteract it. But certain themes have emerged.

CalPERS and CalSTRS, for example, have both championed a multi-pronged, holistic approach that combines policy advocacy, corporate governance, and investment as a means of facilitating energy efficiency and CO2 trading.

Of course, investors can only manage something that can be measured. And a variety of climate-change related metrics are being developed. The UN Joint Staff Pensions Fund (UNJSPF), for example, adopted sophisticated models to assess the portfolio-wide impacts of various emission scenarios.

The Financial Stability Board (FSB)’s Task Force on Climate-Related Financial Disclosures (TCFD) has a host of worthwhile recommendations and has helped propel ESG’s evolution in relation to climate change. The TCFD helped inspire the Ontario Teachers’ Pension Plan (OTPP) inaugural Climate Change Report, which assesses how it is managing climate change-related issues.

3. Diversity and Inclusion

The benefits of diversity in the workplace and in investing have been amply demonstrated. Numerous studies have shown that diversity — of gender and ethnicity, among other factors — yields tangible positive results. Yet whether in the boardroom or the C-suite, actual personnel demographics have failed to catch up to the science. Key decision-makers remain predominantly male, for example, and often do not reflect the make-up, ethnic or otherwise, of the larger population. And compensation gaps, even in the same job, are common.

Addressing these shortfalls has become a central focus of ESG investing.

In 2018, asset owners representing more than $6 trillion in AUM unveiled the G-7 Investor Alliance. The partnership’s ESG priorities ranged across a variety of initiatives, but opening opportunities for women in finance and investment worldwide was among its main goals. To help operationalize the approach, CFA Institute and its global network of societies were selected to establish programs to help eliminate gender inequality.

In “Driving Change: Diversity & Inclusion in Investment Management,” CFA Institute identified 20 specific strategies to address the diversity deficit in the finance sector.

4. ESG Indexation

The active vs. passive debate is playing out in how asset owners approach ESG and is influencing their policy portfolio in a variety of ways.

The New York State Teachers Retirement System (NYSTRS) explicit domestic equity targets an allocation of 20%/80% active/passive. Since institutional-scale ESG index funds have been available since at least the launch of the Vanguard Social Index Fund in 2000, the widespread embrace of such vehicles by asset owners was all but inevitable.

CalSTRS, meanwhile, has put its capital to work at the crossroads of gender diversity and smart beta indexing, emerging as a cornerstone investor in State Street Global Advisor (SSGA) SHE ETFs. It turns out, right now only about 190 companies out of the largest 1,000 publicly traded US companies meet the ETF’s diversity standards.

At last year’s Asset Owner ESG Summit, GPIF’s Mizuno discussed investing in FTSE Blossom Japan Index and MSCI Japan ESG Select Leaders. Over the last 12 months, GPIF expanded S&P/JPX Carbon Efficient Series and MSCI Empowering Women Index, among other specialized funds, and now has over $25 billion invested in ESG-related strategies.

5. Frameworks and Standards

One of the key questions ESG investing seeks to address is how to promote long-term sustainability. Large sovereign wealth funds, the NZ Super Fund among them, have indicated that a clear One Planet framework is a necessity.

The One Planet framework focuses on climate change, in particular, and has specific recommendations for countries based on their stage of economic development, with an emphasis on voluntary action.

Leading asset managers such as SSGA have embraced this framework as a practical way to align with their clients as well as their peers. As ESG develops, its standards and terminology will continue to evolve, with APG, CalPERS, CalSTRS, NYCERS, OTPP, and TIAA, among other asset owners, playing active leadership roles as part of the Sustainability Accounting Standards Board (SASB).

6. Active Ownership

Shareholder democracy is another critical instrument in the asset owners’ ESG toolbox.

As owners and potential owners of company stocks, they can leverage their real or potential equity to influence that company’s policies.

The Council of Institutional Investors (CII) has explored and shaped how asset owners engage with the boards and management of the companies in their portfolios since 1985. Its influence is considerable: The CII is composed of 135 asset owners with AUM totaling $4 trillion.

The Enron and WorldCom scandals of the early 2000s, not to mention the global financial crisis, have accelerated the paradigm shift toward active ownership. Portfolio companies — and society as a whole —are well served by clearly articulated corporate governance principles, like those espoused by the Florida State Board of Administration.

While active ownership comes with a price in terms of both time and resources, the efforts are worthwhile, particularly in the ESG context. Indeed, active ownership is one of the most effective risk mitigants and enhancers of investment returns, according to PRI.

7. Integration

What is ESG integration?

At a broad level, it refers to “the explicit and systematic inclusion of ESG factors in investment analysis and investment decisions,” according to Guidance and Case Studies for ESG Integration, published by PRI and CFA Institute. What that means is, “It is a holistic approach to investment analysis, where material factors — ESG factors and traditional financial factors — are identified and assessed to form an investment decision.”

The emphasis on holistic is essential. Integration means ESG criteria influence investment analysis at every level, from security selection, to asset allocation, and beyond.

Moving Forward

Positioned as they are at the summit of the investment industry, asset owners are poised to better inspire and drive ESG action.

How ESG investing develops will be shaped in large measure by the management teams and stakeholders of asset owners from across the globe, many of whom will converge on New York City for the 2nd Annual Climate and ESG Asset Owner Summit.

ESG investing is still in its infancy and a novelty to many investors, and how it evolves in the years ahead is far from clear. But while its future is unwritten, through their varied approaches to ESG, the world’s largest asset owners have already rendered their judgment: Whatever it looks like, ESG is the future of investing.

For more on environmental, social, and governance (ESG) investing, check out Handbook on Sustainable Investments from the CFA Institute Research Foundation.

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All posts are the opinion of the author. As such, they should not be construed as investment advice, nor do the opinions expressed necessarily reflect the views of CFA Institute or the author’s employer.

Image credit: ©Getty Images/Vito Palmisano

About the Author(s)
Thomas Brigandi, CFA

Thomas Brigandi, CFA, is a vice president in the global investor management team at a credit rating agency (CRA), where he is responsible for building and maintaining a network of senior level institutional investor relationships. Prior to this role, Brigandi served for nearly a decade in the global project and infrastructure finance group at a CRA, where he was a lead analyst responsible for a portfolio of 34 power, toll-road, airport, port, water, wastewater, natural gas pipeline, and project finance credits that collectively had over $15 billion of debt outstanding. Brigandi also served on a CRA's public pension steering committee, ESG Americas working group, and veteran recruiting sub-committee. Brigandi previously worked at the ~$200bn NYC Pension Fund, where he focused on energy and natural resources and reported directly to the chief investment officer. Brigandi is vice chair of the board of directors of CFA Society New York (CFANY), the largest CFA Institute Society globally. Brigandi, the CFA Institute Inaugural Global Outstanding Young Leader and CFA Institute 2021 Americas Volunteer of the Year, has organized over 90 CFA society conferences globally that were attended in-person by over 16,000 investment professionals, in addition to over 35 virtual conferences that reached many thousands of participants. These events featured over 350 senior asset owner and investment consultant speakers who represent organizations that collectively oversee or advise on more than $75 trillion in fiduciary assets, in addition to over 200 senior asset manager speakers who represent firms that collectively manage in excess of $30 trillion in assets. Brigandi, the founder of CFANY’s Asset Owner Series, Global Policymakers Series, Emerging and Frontier Market Series, Putting Beneficiaries First Series, and Global Infrastructure Conference Series, leads a team of over 500 investment professional volunteers globally. While serving as the director of global volunteers of the American Foundation for African Children’s Education, Brigandi organized the NASDAQ Closing Bell Ceremony on 23 September 2011, hosted for the president of Sierra Leone. Brigandi maintains over 14,000 connections ‎on LinkedIn and holds a bachelor's of science in finance, accounting, and Economics from the Macaulay Honors College (MHC) at the City University of New York. Brigandi received the college’s inaugural Alumni Pioneer Award and serves on the MHC Foundation board of directors as treasurer. Finally, Brigandi serves as an advisory board member of the Singapore Economic Forum.

Paul Kovarsky, CFA

Paul Kovarsky, CFA, is a director, Institutional Partnerships, at CFA Institute.

Paul McCaffrey

Paul McCaffrey is the editor of Enterprising Investor at CFA Institute. Previously he served as an editor at the H.W. Wilson Company. His writing has appeared in Financial Planning and On Wall Street, among other publications. He is a graduate of Vassar College and the Craig Newmark Graduate School of Journalism at CUNY.

1 thought on “The Seven Asset Owner Approaches to ESG”

  1. Paul OBrien says:

    I am puzzled.

    I understand and agree with the growing interest in ESG investing.

    But, carbon emissions continue to grow and the world is far from a path consistent with keeping global warming below 2 degrees Celsius.

    So, what is the point? Is ESG about virtue signaling and making investors feel good, or is it about achieving material change? Counting the amount of assets in ESG mandates is not the right metric if you care about the planet.

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