‘Asset owners’ don’t need to drive ‘ESG’ into 'investment': A tale of three umbrellas

For years, we have heard the opinion that “asset owners need to drive ESG into investment” and we’ve accepted it as accurate and self-evident. It stands to reason that sustainable and responsible investment can only grow sustainably if the institutional investors responsible for allocating assets at the top of the value chain determine that it is what they want.

However, while the sentiment is broadly true, it is a generalisation that hides three simplifications - each of which significantly hinders our progress as an industry:

• There is no such thing as an 'asset owner'
• There is no such thing as 'ESG'
• There is no such thing as 'investment'

None of these things are single elements, they are all broad umbrella categories. If we want to move our industry forward, it is time to ditch the generalisations, get beneath the umbrellas and start to deal in specifics.

There is no such thing as an ‘asset owner’

'Mainstream' institutional investors don't think of themselves as 'asset owners'. Instead they think of themselves as pension funds, insurance funds, foundations, family offices etc.

(If you don't believe me, type the phrase ‘asset owner’ into Google. You’ll find that www.sri-connect.com comes up as one of the top responses. But I’m the editor and owner of www.sri-connect.com and I have serious reservations about the term. I also apply the general rule: When you reach the edge of Google, it's probably time to stop paddling and turn the boat around.)

The term 'asset owner' had value as a way of catching the investment industry's attention and persuading us to think in broad terms about the significance of the investing institutions that sit at the top of the investment value chain and bear ultimate responsibility for the ownership and allocation of assets.

However, it is less useful when it comes to understanding how each of these different institution types invest and how they could apply sustainability and corporate governance practices to this investment activity.

Put simply, an insurance company has very different investment priorities and processes to a small family office … which, in turn, is likely to have a different approach to a pension fund or a foundation.

A family office might require a fundamental active manager to pick growth (environmental) technology equities to preserve and increase the family's wealth for the next generation while an insurance company might require a quants manager to use corporate governance factors to optimise a broadly-diversified fixed income portfolio to avoid blow-ups.

There is no such thing as 'ESG'

Of course, ESG is not a single thing either. It is a grouping of three groups of factors: Environmental, Social and Corporate Governance. It's an umbrella term of umbrella terms.

What is more, the linkages between the three categories are not particularly strong.

Environmental factors deal with business' relationship with the physical environment; social factors deal with business' relationship with the human environment; (economic factors are overlooked by the initialism deal with business' relationship with their economic environment); while corporate governance deals with the top-level of how a business manages its activities and communicates with investors.

Not only do they deal with different issues; they are structurally different concepts.

More importantly, the different factor sets play through the investment valuation process in very different ways. Environmental and social factors can affect revenues, costs, assets and liabilities and are therefore best dealt with through fundamental bottom-up analysis. They can present upside or downside opportunities and can often be fed (often via scenarios) into the inputs to a valuation process.

Corporate governance factors, by contrast, are typically considered as a risk factor to the overall valuation of a company and are therefore usually applied to the last phase of a valuation model.

A failure to appreciate these critical differences means that the initialism 'ESG' often impedes the integration of sustainability and corporate governance factors within valuation.

There is no such thing as 'investment'

This third argument stretches the point. Of course, 'investment' is a thing.

However, it is also a multiplicity of different things … of different investment strategies that operate within a different asset classes and are undertaken to achieve different investment outcomes … by different kinds of people (… and sometimes by machines) … with different input needs.

The integration of sustainability and corporate governance factors into the different types of investment will need to be done in very different ways and the information that will be needed to deliver this will be different.

• Quants investors may need consistent, comparable, time-deep, back-tested data across broad indicator sets
• Fundamental investors are unlikely to find this useful and are more likely to want thorough contextualisation of a company's approach to a single value-driving sustainability factor
• Active investors will want detailed counter-consensus analysis of sustainability factors that are not yet priced by the market
• Passive investors have no use for this and will want broad screens and engagement prompts

From awareness to allocation

Insisting that 'asset owners' need to drive 'ESG' into 'investment' may have been a useful motivating call over the past ten years ago. However, we are beyond the point at which it serves much purpose. Awareness has now been raised.

If we are to succeed in the next 'allocation' phase of our industry's development, we need to understand that:

• Different investor types (no longer 'asset owners')
• Will apply different sustainability and corporate governance factors (no longer 'ESG')
• To different investment strategies (no longer 'investment')

…and we're going to need to understand the points of overlap between the three.

It's getting granular; it's getting complicated; it's getting exciting…

(Mike Tyrrell will be discussing aspects of this diversity at the Global ESG Investment Forum in London on 26 & 27 October with investors from across the investment spectrum: Mark Fawcett, Luca Grassadonia, Urs Bitterling & Ioannis Ioannou)