The investment consultancy analysed several fund manager searches by institutional investors, concluding that using basic ESG requirements that are common place in some asset classes may severely restrict choice in others.
To illustrate that point, bfinance recalls one manager selection process for U.S. small-cap equity: because of its requirement for the chosen manager to be a signatory to the UN Principles for Responsible Investment (PRI). Because few US small cap managers have signed up to the UN PRI, “our European pension fund client saw their shortlist shrink from 20 to just two,” bfinance notes.
To screen or not to screen?
The consultancy therefore suggests (institutional) investors should tune down their ESG requirements for asset classes that are at an early stage of ESG integration, giving basic ESG indicators only a single-digit weighting in the first step of the quantitative analysis. Another example of such an asset class is private debt, where ESG issues have ‘limited materiality’, according to Mark Mansley, CIO of the UK Environment Agency Pension Fund, which tends to attach naturally high importance to ESG factors, but not so in this case.
Stronger initial ESG screening is more appropriate when ESG-based investing is more developed, according to bfinance. An example of such an asset class where this is the case, is global equities. Four in 10 funds in this category employ some sort of initial ESG screening, according to bfinance.