Part 2: Climate Change Investing
The 10x10 report
Part 2: Climate Change Investing
Who’s leading the way on investing for the E in ESG? What’s driving progress and innovation? What’s preventing it? And why is climate change a priority for some organisation and managers more than others? This report will look at climate-change investing with the objectives of both asset managers and asset owners firmly in hand.
The 10x10 Report—independently implemented by research consultant, Cerulli Associates—addresses these topics from the points of view of 10 of the world’s leading institutional investors. Those views are then contrasted with 10 of the world’s leading asset managers.
Kate El-Hillow
President & Chief Investment Officer, Russell Investments
About the 10x10 report
In 3Q 2021, Russell Investments held its annual Partner Innovation Lab, a roundtable event where large asset owners from various countries brainstorm their greatest concerns and areas of interest. We asked Cerulli Associates to interview participating organisations, as well as some of our asset management partners, to extract individual perspectives on topics discussed at the event.
The result is a three-part series:
Part 2: Climate Change Investing
(This report)
Participating institutional investors included the following corporate retirement plan sponsors, in alphabetical order: The Boeing Company, Fujitsu Global, Mazda Motor Corporation, Microsoft, Mitsubishi Electric, Nestlé, Roche and Unilever. It also included the following non-profit investors: The New York Presbyterian Hospital, Robert Wood Johnson Foundation and Thomas Jefferson University.
Participating alternative asset managers included: Brevan Howard, Hamilton Lane and Oaktree Capital Management. Participating fixed-income asset managers included: BlueBay Asset Management and Western Asset Management Company. Participating multi-asset-class managers included: BlackRock, J.P. Morgan Asset Management, Morgan Stanley, Putnam Investments and Wellington Management.
Climate change investing trends
Compared to asset managers, asset owners were more varied in their adoption of climate metrics in their investment processes, according to participants in the 10x10 report. Several managers have built out proprietary research initiatives, leveraging their size and resources to provide more insights into climate initiatives. Among asset owners, non-profits have generally made greater strides on the climate front.
From the experts:
“Our engagements are about asking meaningful questions, and how to improve it. We often own a sizeable portion of our investments so we can influence things in that way.”
- Asset manager
"[We are] engaging with investment managers to make sure that you are taking proxy and voting into consideration. Are they a) voting our shares, with respect to socially conscious initiatives and, b) are they engaging with the companies?"
- Asset owner
Investment portfolios are also used to help with organisation-wide climate goals. Several asset owners have sought to offset their carbon footprints via their investment portfolios, investing in technologies like carbon recapture. Some have set up separate portfolios to do this. Asset managers have sought to provide these types of investment options for their clients, as well as investing their own corporate funds into various technologies.
Climate focus catalysts
Asset managers told Cerulli that their adoption of sustainable investing capabilities is primarily driven by external client demand. Managers generally believe that clients bear the ultimate responsibility in adopting a climate change investing lens. While asset managers take their own measures, internally, to combat climate change, most have clients that do not consider ESG metrics at all and, as fiduciaries, they must invest in a way that is in line with their clients’ objectives.
For asset owners, on the other hand, internal values are the key driving force behind their adoption of environmental metric considerations. Sometimes these internal values emerge from the investment office itself, and other times they trickle in from other parts of the organisation. In addition, some asset owners are beginning to adopt a climate focus simply because they project that climate change investing is inevitable.
From the experts:
"We saw that first being relevant in Europe, then Asia and now the U.S. The idea of investors using assets to sponsor initiatives that they believe in, relating to climate change, this is how I experienced that more over the years. [It] started in Europe a decade ago. Once investors start valuing that, regulation follows."
- Asset manager
"ESG will be an important issue. It will become common to think about ESG factors for mutual funds in the future. Success in ESG products depends on whether the resolution of social problems using ESG will lead to firms’ business expansion."
- Asset owner
Strategic partners & dedicated resources
There are significant challenges when it comes to gathering, interpreting, and acting upon data in the climate realm. As such, asset owners often rely on their intermediaries to provide guidance. A non-profit explained that its investment consultants are charged with helping them implement ESG considerations and opportunities. A corporate plan sponsor explained that it collaborates with its consultant on developing sustainable equity options for its DC plan and creating the right management structure. Another corporate plan sponsor told Cerulli that its consultant plays a pivotal role in collecting and consolidating data.
In response to ESG demand, asset manager participants said they have built functions or assigned dedicated resources to addressing climate investing. Several managers have hired heads of ESG to assist in developing frameworks and ultimately integrating ESG policies broadly. Some asset owners report hiring heads of ESG as well, although this is a bit rarer as the investment offices tend to be limited in size. ESG heads are often charged with leading their companies’ proprietary climate research efforts and, in some cases, heads of ESG were also responsible for promoting their companies’ diversity, equity and inclusion (DEI) efforts.
From the experts:
"I think they (heads of sustainability and diversity) are essential. It depends on what you want to do—do you want to approach it as an amateur? Or do you want to deliver expertise on these topics?"
- Asset manager
"ESG was a special case. We really needed to have a specialist in that role ... my ESG person basically put up a grid that is now the standard approach. Before, everyone had their own opinion on it, so there was some initial pushback. I think it is important to have that sort of expertise."
- Asset owner
Climate data
In addition to other challenges, industry participants struggle to find consistent data across the universe of companies. As asset owners and managers continue to streamline their processes, they are likely asking U.S. companies for the same metrics that European companies are required to disclose, providing an avenue through which there could ultimately be some standardisation. That standardisation issue also extends to the definition of ESG and how that lack of a definition impacts data and reporting.
From the experts:
"What’s the definition of ESG? You might get 10 answers from 10 people. Tesla—one vendor has them top quartile and [another] one had them bottom quartile. So where does that shake out?"
- Asset owner
"We use a third party to measure carbon footprint, things like that. That will be the friction point—what are you measuring? Did you eliminate this amount of carbon, or provide food for this number of people? No one knows right now."
- Asset manager
Barriers to adoption
The most oft-cited barrier to implementation is regulatory hurdles, specifically rules surrounding financial factors. U.S. corporate plan sponsors say that they have not integrated climate considerations because they fear going against Department of Labor (DOL) guidance.
Among firms that have not taken steps, one of the primary reasons was that they did not want to exclude potential investment candidates from their selection processes. A non-profit told Cerulli that energy sectors that contribute to global warming are often necessary and that it did not wish to exclude entire sectors from its investable universe. A corporate plan sponsor from Japan also told Cerulli that its plan participants are generally not interested in restricting their investment options for the sake of climate initiatives.
Another factor preventing a fully integrated climate stance is the uncertainty in how to look at passively managed assets. A corporate plan sponsor that allocated a large portion of its assets to passively managed strategies told Cerulli that exclusions are one of the only tools it can use for those assets.
From the experts:
"ESG was on our project list last year, in terms of developing a policy or implementing specialised investment options, but until we knew where the regulations were going, we couldn’t justify focusing on it."
- Asset owner
"A lot of our assets are passive, so exclusions are really one of the only tools we have in this area. While we have a mature framework, it is not aggressive."
- Asset owner
This is just a snapshot. Download report below.