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MULTI-ASSET INVESTING
AN ENGAGING STRATEGY
Environmental, social and governance investing has evolved far beyond a process based on exclusion to one that is inclusive, activist and focused on alpha. Institutional investors are addressing the dual purpose — to effect change and generate alpha — via a range of sustainable investment approaches, typically impact funds, asset-specific ESG strategies or multi-asset portfolios.
Across all approaches, the state of investing based on ESG factors is robust. Global ESG assets under management were $35.3 trillion in 2020, up 15% from $30.6 trillion in 2018, according to the Global Sustainable Investment Alliance. ESG’s portion of total global AUM rose to 35.9% from 33.4% in the same period.
ESG: Multi-Asset Investing Webinar
Featuring
The right approach
While a multi-asset strategy can be one of several ways to implement an ESG investment approach, Dulari Pancholi, CFA, CAIA, principal and head of credit and multi-asset at NEPC, said that she sees multi-asset as the right approach for asset owners today.
“The way ESG investing has evolved almost requires you to take a multi-asset approach,” she said. “The investible universe has expanded so much beyond the listed stocks where ESG originated. Now there are asset classes like private debt and private markets, or debt more generally, [and they] are tougher to work with” in terms of the availability of ESG products and challenges in ESG data collection. “In the fixed-income space, for example, you now have green bonds, which are an evolution of green revolving-loan facilities. There are term loans that are tied to sustainability metrics and sustainability-linked bonds that are tied to the ESG performance of the portfolio or underlying company.
“So if you’re trying to build an ESG portfolio that can integrate some or all of the available asset classes, you need a toolbox that can hold a lot of different tools. That’s what multi-asset is all about,” Pancholi said.
While many asset owners are adding ESG criteria to their existing analytical frameworks, others are adopting ESG-only allocations to specific asset classes, introducing ESG themes in one or more asset classes, or taking a multi-asset approach across the entire portfolio or via dedicated multi-asset allocations.
An active commitment
ESG investing has been through a process of evolution and is currently at the stage of shareholder advocacy and engagement.
“We’re seeing a lot of state pensions and endowments increasingly engaging with corporations, either directly with management or through proxy voting,” Pancholi said. “These investors are saying that it’s more constructive to ask companies to make changes in their business models than to completely eliminate the companies from the portfolio.”
While not a panacea, engagement with companies that may not be best in class but are open to improving their ESG profile can be a powerful way for investors and their managers both to try to effect ESG-based change and to find attractive opportunities for alpha. As Sunny Ng, CFA, global multi-asset portfolio manager at PineBridge Investments, put it: “If we only invest in companies with very strong current ESG profiles, we’re not rewarding those which may have less desirable ESG characteristics currently but are improving very quickly. By not investing in and engaging with these companies, we don’t have a seat at the table to encourage continued improvement.”
Ng pointed to the energy industry as an example of what engagement can accomplish. “There are energy companies that are aiding in the transition to new energy, and they’re actually some of the biggest investors in green energy in the world at the moment,” he noted. “They’re investing a significant amount of their capital expenditure budgets into green infrastructure because they know that their core business is at risk as we move toward a net-zero [carbon emissions] world. There’s a case to be made that these companies are worth investing in and engaging with, from an ESG standpoint, because we can continue to encourage that transition.”
Ng further noted that ESG engagement can create value and, thus, increase potential alpha. “Companies that are improving their ESG profiles are also building cash flows that are more sustainable. All things being equal, we believe a company with more sustainable cash flows should be valued higher than one with less sustainable cash flows. If we invest in [the more sustainable] companies and encourage them to do that, we’re actually driving value at the same time as driving ESG improvement.”
A top-down perspective
Implementing ESG into a multi-asset investment approach brings its own challenges, both for investors and their asset managers, in terms of outlining a total-portfolio framework, and meeting ESG objectives in private markets is complicated by the fact that ESG data is less developed.
According to Deanne Nezas, CFA, FSA, MAAA and global multi-asset portfolio manager at PineBridge Investments, “Institutional investors are trying to implement ESG frameworks grounded in best practices. Within our team in particular, we interact mainly with institutions that are asset allocators like we are, so we’re dealing with many of the same challenges that our clients are in terms of developing a framework for ESG.”
PineBridge is seeing increasing interest from asset owners who are considering a top-down approach to ESG, Nezas said. “It’s no longer enough simply to outsource the ESG mandate to a security selector. Plan sponsors acknowledge the need to understand the ESG impact of each asset class and the special considerations involved. Having a top-down ESG view at the asset-class level is becoming increasingly important, so we’ve developed a top-down framework to reflect that view in portfolios.” (See chart on page 4 on the ESG review process.)
Nezas also pointed to the challenges of assessing the ESG impact of private-market assets in a multi-asset portfolio. “There’s still a lack of standardized key performance indicators for public and private companies and thus a significant need for data transparency and disclosures,” she observed. “There isn’t a clearly defined road- map for measuring the ESG impact of private companies in a multi-asset context.”
Steps in an evolution
To gain perspective on the current state of ESG multi-asset investing, it is helpful to examine how investor thinking evolved before embracing the current active engagement approach.
ESG multi-asset investing originated as a way for faith- and values-based organizations to, essentially, put their money where their mouth was, said Pancholi at NEPC. “They wanted to express their moral beliefs in their investment choices. The easiest way to do this was to exclude certain types of businesses from their holdings [by] using negative screens, particularly for so-called sin stocks like tobacco and alcohol companies. It’s still the easiest approach to ESG investing, but there’s much more that investors and their asset managers can do, and are doing, now.”
In NEPC’s view, negative screening was the first of four “pillars” or stages of ESG evolution, followed by the second pillar, ESG integration (see chart on the four pillars approach).
“The focus of integration,” Pancholi said, “was whether all strategies that allocators were investing in incorporated the considerations from the E, the S and the G materiality into their portfolio construction decisions. Did the investment manager look at all of the risk factors involved? And after looking at those risk factors, was the position valued appropriately in the portfolio and sized accordingly?”
The third pillar of ESG evolution was for state pensions, endowments, foundations and private wealth clients to seek a positive ESG tilt in their portfolios without compromising returns. “Most of these allocators,” she noted, were focused on making returns plus having an impact. Their thematic ideas tended to be on the private-market side and focused on things like renewables, job creation, community development and more. “It’s almost the polar opposite of negative screening,” Pancholi said.
Key Drivers of progress
Data is a huge issue for ESG investing, particularly for multi-asset vehicles that encompass numerous asset classes and subclasses as well as a mix of public and private holdings. Several data-related challenges, whether regarding alternative investments or private markets and data integrity more broadly, need to be addressed, said Patricia Torres Leandro, global head of sustainable finance solutions at data provider Bloomberg.
Supply and demand
Demand for ESG data across the investment ecosystem is huge and originates from government mandates around the world that prioritize ESG goals, ranging from net-zero carbon emissions to social impact investing. Regulatory data-reporting requirements work their way through the ecosystem to affect asset owners, asset managers, publicly held companies and, increasingly, private-market entities. While the supply of ESG data is improving, it is still insufficient because those regulatory requirements are overwhelming and inconsistent, and privately held companies have not had to disclose much historically.
“There’s a huge effort from asset managers to go back to private companies,” Torres observed, “and ask them to provide the information that the manager needs to report. This work is much easier for investments in publicly listed companies than for investments in infrastructure projects, real estate, private equity or even derivatives.”
Meanwhile, NEPC’s Pancholi pointed to the sheer quantity of ESG data that plan sponsors and their advisors must consume as part of their due diligence process. “They’re drowning in the due diligence documents and frameworks that they feel pressured to respond to,” she said. “And depending on which stakeholder you talk to in this ecosystem, the framework is different. There are different approaches for regulators, asset allocators and consultants, for example.”
Despite the challenges, Pancholi sees a bright side: “Some managers are taking the next step and using the situation to their own advantage by building proprietary databases of all the data that the ecosystem is looking at. They’re leveraging the marketplace’s complexity to make themselves more competitive.”
Read: ESG Asset Class Report
Data integrity
“Data integrity” is a catch-all term that covers ESG data standardization, accessibility, accuracy and reliability — all of which are inextricably linked. “It can be challenging to achieve an acceptable level of data integrity with many ESG approaches, including the multi-asset approach,” Bloomberg’s Torres said. “The lack of consistent company-reported data is the greatest challenge, both for the industry and regulators.
“Reliability and transparency of ESG data are crucial,” Torres added. “It’s one of the first things that clients ask us about. They’re very concerned about even the perception that their portfolios or managers might be greenwashing.”
“At Bloomberg, we go through a rigorous process of understanding if the data is good or bad and, unfortunately, we see a lot of errors. So even when a company proactively discloses data, if the data is not verified, it invariably has mistakes,” she said.
Another contributor to data unreliability is the time gap between companies’ release of financial and ESG reporting. “This gap can be as much as nine months to a year,” Torres observed. “We really need to eliminate it. ESG data must be integrated in the annual report and fully verified.”
Ultimately, of course, standardized and trustworthy data is useless if it isn’t accessible — and Torres said that accessibility is a big problem. “We need to ensure that market participants have access not just to the data, but also to the technology that can automate it,” she said. “The bottom line for accessibility is that data needs to be machine-readable. A lot of companies are still disclosing the data in textual form, so Bloomberg employs people to read 300-page corporate sustainability reports to find the data. Making a template that’s machine-readable will reduce any market participant’s cost of data and greatly boost the chances of getting the data right.”
Need for credible benchmarks
Another data-related topic that hasn’t gotten its fair share of attention, according to Torres, is the provision of credible ESG benchmarks for asset owners and managers. In her view, industry participants need to be more rigorous when selecting benchmarks to ensure that their choice accurately represents the ESG investment universe by which they want to be measured.
“Asset owners’ choice of benchmarks sends a very strong message about their commitment to ESG investing,” Torres said. “We’re seeing this in Europe, where many asset owners are shifting their investments to the equity and fixed income Paris-aligned benchmarks [on net-zero carbon emissions targets] that follow specific regulations.”
Read: ESG Digest – Sustainable investment news and insights
The investment community needs to have a broad and thorough discussion about best practices when selecting ESG benchmarks, Torres said. “Are the benchmarks credible? Do they get data from credible sources? Do they have rigorous methodologies? Is there a clear, well-defined process for how companies are included or excluded?”
While Torres said that Europe is the uncontested leader in ESG benchmarking, she encouraged asset owners everywhere to be selective when adopting benchmarks. “We need the asset owners in the U.S., Asia and the Middle East to join their European counterparts to support rigorous ESG benchmarking standards,” she noted. “Once the owners declare, ‘This is my sustainable benchmark,’ then everything trickles down, because their managers need to follow that benchmark and report on those assets using those sustainability metrics.”
WORKING TOWARD GLOBAL STANDARDS
It is reasonable to say that, aside from investor demand, regulation plays the biggest role in ESG investing. A major issue in ESG regulation is that the rules are dramatically different in different jurisdictions, creating a patchwork of requirements that investors and managers struggle not simply to meet, but also to reconcile. This regulatory gap is widest between Europe — where regulatory oversight is strongest — and the rest of the world, notably the U.S.
“Europe has been doing ESG integration and regulation the longest and they’ve developed strong frameworks around it,” said PineBridge Investments’ Ng. “Asia is catching up pretty quickly. In the U.S. it’s very different, depending on the type of institution you’re talking about. Is it a university foundation where the stakeholders demand more ESG integration or is it a state government plan that has different considerations around ESG? Everyone’s thinking about it, but the speed at which everyone’s moving is very different.”
“The emergence of regulation is a challenge for all parties, whether it’s for a multi-asset or single-asset portfolio,” Torres pointed out. “Since ESG investing is done by managers all over the world, regional or country-specific regulation has an impact that extends across borders.
“Investment firms, whether based in Europe or marketing their funds in Europe, will need to report how aligned their investments are with the European Union Taxonomy, regardless of their investment strategy. So even if you’re an American company, you need to think about publishing the information that the EU requires of EU companies, if you want to attract EU investors.”
Torres noted that countries in other regions are also actively trying to regulate ESG investing domestically. In the U.S., for instance, the Securities and Exchange Commission in May proposed two form and rule amendments, one to enhance and standardize disclosures related to ESG factors, and another to expand the regulation of naming ESG-focused funds. (See chart above.)
For Torres, regulators everywhere ultimately must collaborate to establish global standards that support the development of sustainable investing and finance. “There’s a broad recognition that global standards are essential, and regulators are working hard on global interoperability of regional standards. They understand that we need to make the work of global investors much easier.”
PICK THE RIGHT CO-PILOT
Given the inherent complexities of ESG integration and multi-asset investing, asset owners should be especially diligent when searching for asset managers. What are the table stakes for managers? How can they stand out from the crowd? And how do they position themselves to meet the burgeoning demand across the ESG ecosystem? There’s a vast divergence in asset managers’ approaches to ESG investing and the capabilities they deliver to investors, and industrywide the table stakes aren’t yet evident.
Sunny Ng at PineBridge sees a clear choice for asset managers. “On one hand, there are managers that have taken a well-thought-out approach to ESG that adds value, and on the other, some have taken the easy route and have just excluded specific industries and companies based on published data. Managers that are doing the latter and labeling themselves ESG are charging a pretty high premium to investors for something that doesn’t add value,” he cautioned. “It will become increasingly important for investors to know how to differentiate between the two types.”
As plan sponsors’ analysis of their own portfolios and managers’ ESG process and performance becomes sharper, Ng added, they “will have a significant incentive to add managers that can help their overall portfolio-level ESG characteristics. When they’re looking to add a new multi-asset manager, they’ll want one that’s going to help them from an ESG standpoint rather than harm them. We think it’ll become more evident who’s done a good job and who hasn’t, and sponsors will award their mandates to those who can add ESG value.”
When considering table stakes in selecting asset managers who can deliver on ESG objectives, the managers’ integration of material ESG considerations in their investment process is “the basic ask,” said NEPC’s Pancholi. Table stakes, she said, are “factors like regulation, how companies are transitioning to net-zero [carbon emissions] and ESG’s effect on profitability, and then assessing those factors’ impact on a company’s valuation. That’s the minimum that asset managers must do.”
When it comes to choosing multi-asset managers, plan sponsors can help them distinguish themselves by being specific about the investment objectives they want each manager to achieve, according to Nezas at PineBridge. “It’s important for institutions to think about why they want to [refer to] a mandate as ESG multi-asset,” she noted. “Is it because they want that multi-asset mandate to add something to their portfolio they don’t currently have? Is it important that it’s labeled as ESG? Do they simply want to exclude assets with poor ESG characteristics?
“If they’re looking for a multi-asset manager whose process meets their requirements from an ESG-integration standpoint,” Nezas added, “that’s just a multi-asset search, and they should have a requirement for ESG standards for their multi-asset managers. But if they want a specific ESG multi-asset product, what’s the product’s objective? By defining what they’re looking for, sponsors can compare different multi-asset managers along those specific dimensions.”
Tailwinds gain speed
The outlook for ESG multi-asset investing is positive. Strong tailwinds should keep pushing the strategy forward in terms of market acceptance and assets under management.
Nezas said she sees a growing awareness that investing for impact can deliver alpha. “One of the tailwinds driving the adoption of ESG investing across institutional portfolios,” she said, “is the recognition of the connection between the impact investors can have, improvements that can be made across the ESG landscape and the alpha that ESG improvement can deliver. There’s a broader recognition that this could drive alpha in the portfolio instead of taking it away.”
PineBridge’s Ng agreed. “We’ve seen quite a bit of research on whether a forward-looking approach that focuses on investing in companies [with] improving ESG characteristics actually leads to alpha,” he said. “We’re also doing our own research on that and have concluded that the evidence points toward that interconnection empirically. Moreover, going forward you can imagine that as investors increasingly focus on ESG, there’ll be a self-fulfilling prophecy, where companies that are improving their ESG characteristics more quickly will be more sought after, and therefore their cost of capital will be lower. Ultimately, we believe these companies would likely outperform their less-sustainable counterparts.”
Another tailwind is the momentum building in the marketplace for noninvestment factors that will help ESG strategies reach the next level of maturity, said Pancholi at NEPC. “Big increases in disclosures, standardization, efficiency and information will definitely benefit asset owners and managers who are already paying attention to them. I think that’s going to be the key for risk management going forward.”
Pancholi’s reference to standardization is especially relevant for the data that asset owners and managers need in order to construct, manage and monitor their ESG portfolios, and to report on them.
Bloomberg’s Torres said her company is helping to lead the way. “We are committed to providing clarity on the purpose of our scores, full transparency of our methodologies and the data lineage of source documents so that clients truly understand how our scores are designed. And to take it a step further, if they prefer, clients can use our data to create their own scoring using their own methodologies.”
Ultimately, Torres said, “Every single player has a role to play in the fight for sustainable investing. More regulators are bringing clarity and mandating disclosure. Asset owners and managers are working to make portfolios more transparent and measurable to keep in step with their own client needs and regulatory requirements. Bloomberg’s role is not only to provide better data with greater transparency, but also to engage with stakeholders on the issues of sustainable investing and to help the industry solve them.”
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