Overcoming ESG hurdles: From data to impact

Executive summary:

Careful data management and having a formal impact measurement framework in place are essential to preventing greenwashing and ensuring consistent impact delivery.
Best practices are required for asset classes such as private markets that lag behind in terms of adoption and responsible Environmental, Social and Governance (ESG) practices.
Investing in a way that actively contributes to a more sustainable future requires a deeper level of scrutiny and a more careful application of ESG data than adopting a simple de-risking approach.
Managing sustainable risk requires a consistent and efficient process for identifying risks that pose financial materiality, striking a balance between the expected risk with expected reward.

In pursuit of financial and sustainable objectives for our clients, Russell Investments has encountered several challenges stemming from the inherent limitations of ESG data.

These limitations include poor data coverage, lack of comparability among data providers, weak correlations to actual corporate performance, and the challenges of using backward looking data to invest with foresight. We have learned that harnessing ESG data in support of investment results requires creativity and agility, but also beneficial practices and high-value solutions that are developed through persistence.

Below we describe four case studies highlighting the use of ESG data and practices in our investment process.

Case Study 1: Converting divergent data into cohesive impact fund reporting

Problem: Collecting and reporting on private markets portfolios presents unique data challenges due to differences across asset types, structures, and key operational metrics. ESG reporting is hampered by these hurdles as well as a lack of consensus around templates and metrics.

The challenge is heightened for impact funds, which must also establish impact key performance indicators. Inconsistencies between managers are common, but we have found that even individual managers deliver inconsistent or erroneous data from one year to the next. To prevent greenwashing and ensure consistent impact delivery, careful data management and a formal impact measurement framework are essential.

Solution: Our primary aim was to enhance the reporting for our Global Impact Fund, which was incepted in 2015. To launch the project, the team undertook a survey of the landscape in two parts: 1) we surveyed a representative sample of multi-manager peers to compare and contrast best practices, and 2) we reviewed publicly available reporting templates.

Conversations with our peers revealed a wide range of practices, governance structures to supervise ESG objectives, and frameworks to support implementation. Based on this work, we identified the Global Impact Investing Network (GIIN) IRIS+ system as the best fit template for standardisation of the impact data we collect from managers.

The themes of our Global Impact Fund are climate, financial inclusion, and healthcare, so we selected approximately 25 relevant and aligned metrics from IRIS+, out of over 700, and supplemented them with 6 bespoke metrics to reflect our targeted investments more accurately. For example, a manager focused on promoting financial inclusion in emerging markets might report on the number of consumers helped who earn less than $10 per person per day.

Data aggregation and review is a critical step in any impact reporting effort because managers will record even common metrics (e.g. GHG emissions) in different ways. We issue an annual, proprietary impact measurement questionnaire to the underlying managers and then subject this data to scrubbing. We check the data against the previous year, the manager’s impact report, and our separate ESG due diligence questionnaire and work with each manager to confirm accuracy and reliability.

Outcome: We know that impact clients value reporting that shows the real-world, tangible effect of their investment dollars, so we built an online dashboard to warehouse the data, calculate impact, and map the outcomes to the UN Sustainable Development Goals (SDGs). We translate our clients’ investment dollars into specific results, such reporting reduced emissions (300,000 tonnes) as the equivalent number of cars (66,815) kept off the road.

Case Study 2: Promoting ESG transparency among private markets managers

Problem: Russell Investments conducts thousands of manager due diligence meetings per year across asset classes, and within each formal recommendation, we score the manager’s ESG process and capabilities. We also monitor industry trends in responsible investing via our annual Manager ESG Survey, through which we collect and analyse ESG information from hundreds of investment managers. Our efforts show that private markets managers and funds lag other asset classes in terms of adoption of responsible investing and ESG practices, transparency, and ESG reporting.

Solution: We developed a set of “ESG Best Practices” specific to private markets to encourage transparency and accountability. As a first step, we require that all private markets managers respond to our proprietary ESG questionnaire. Research analysts leverage this information and conduct a dedicated ESG review for each manager strategy prior to establishing a formal recommendation and before funding.

Outcome: The assessments and insights, compiled in our internal database, constitute a rare collection of expertise specific to ESG in private markets. Portfolio managers monitor the ESG risks associated with existing holdings via discussions with managers during periodic check ins and at AGMs.

Case study 3: Delivering a systematic “Sustainable Transition” equity strategy for completion portfolios

Problem: Russell Investments began developing ESG risk and decarbonisation overlays for equity strategies in 2015, but our investment professionals recognised that investing in a way that actively contributes to a more sustainable future requires a deeper level of scrutiny and a more careful application of ESG data than a simple de-risking approach. For clients desiring a forward-looking systematic overlay, strategies must be carefully tailored to pinpoint and support businesses and sectors actively progressing towards more sustainable practices, technologies, and operations.

Solution: We designed a systematic approach to identifying securities that captures a company's positive impact on the environment and society while acknowledging the trade-offs between positive and negative outcomes. These securities make up our Sustainable Transition Stock Universe, an opportunity set drawn from a multi-faceted set of criteria including:

Positive Impact Today: We evaluate companies based on their revenues or services linked to SDGs and other positive impact themes.
Emerging Technologies: We consider technologies in development, measured by capital expenditure and patents held. These technologies are critical for driving sustainable change in the future.
Negative Impact Assessment: We assess companies based on the significance of their negative impact. Focusing on significance is critical because all companies have some level of negative impact. Instead, we identify and exclude those with activities that substantially limit their potential to contribute positively to sustainability.

We assessed the effectiveness of our Sustainable Transition Stock Universe using various ESG metrics and confirmed that it offers higher net zero alignment and exposure to sustainability solutions, combined with a lower weighted average carbon intensity than the benchmark. These metrics can further be managed through portfolio construction techniques with relatively little effect on the risk or expected return metrics of the final strategy.

Outcome: Where this work truly shines is in our ability to combine systematic, sustainable strategies with multi-manager portfolios through our Completion Portfolio framework. We build sustainability-focused funds while controlling for the potential factor and sector biases that may materialise at the total portfolio level -- all while ensuring that each name held within the portfolio still meets our rigorous standards for environmental or social impact.

Case Study 4: Leveraging data to manage sustainability risks in multi-manager portfolios

Problem: In 2021, Russell Investments developed and implemented a firmwide Sustainable Risks Policy and practices to identify and manage sustainability risks across our multi-manager investment portfolios. This required that we consistently and efficiently identify those risks that exhibit financial materiality and take actions which balance expected risk with expected reward. Our effort extends across manager review, portfolio management, and implementation proprietary solutions.

Solution: Among other practices, RI implemented a process called Enhanced Oversight (EO) to translate our Sustainability Risks Policy into portfolio management and stewardship actions. This action relies on integrated ESG analysis and various sources of ESG data – both internal and external—and four key steps:

Detect: Conduct a quantitative ESG Risk Analysis. This sustainability risk assessment is applied by portfolio management teams, typically quarterly, using third-party ESG data alongside Russell Investments stewardship outcomes.
Review: Gather qualitative ESG insights from subadvisors on high-ESG risk companies identified through the mix of data in step 1.
Inspect: Use outcomes from the quantitative and qualitative analysis to inform stewardship actions including engagement targets and proxy voting risks.
Engage: Record outcomes from stewardship actions to inform the next round of ESG Risk Analysis and EO action.

Russell Investments uses internal, proprietary tools – called PARIS and ENACT – to execute the EO process. PARIS aggregates Sustainalytics, MSCI, and Planetrics and other data points in a custom view, providing portfolio and security-level ESG data to support quantitative assessments. ENACT was built to house all qualitative insights collected at any time by our stewardship and EO activities – including engagements, third-party collaborations, and insights from subadvisors.

Outcome: The Enhanced Oversight process is an integrated and proactive approach to managing sustainability risks across our multi-manager portfolios which leverages multiple data sets and qualitative investment insights. Clients are eager to understand the scope and effectiveness of our manager oversight and engagement activity, and our proprietary tools support tracking of our activity, outcomes, and client reporting.

If you wish to learn more about any of the processes mentioned in this article, visit our responsible investing page or reach out to your Russell Investments contact.

Any opinion expressed is that of Russell Investments, is not a statement of fact, is subject to change and does not constitute investment advice.