Environmental, social and environmental, social and governance (ESG) issues have risen at the forefront of investors’ minds - and led all fund houses to claim to take the principles seriously. That is forcing asset owners such as the Hong Kong Monetary Authority (HKMA) and Australia's Aware Super to heavily scrutinise potential fund manager partners in order to pick out genuine adherents.  

Asian institutional investors used to have to play catch up to their European peers, but as ESG investing has gone mainstream that gap in expertise has narrowed, while fund managers servicing regional investors have increasingly claimed to be ESG experts.

Today it makes no sense to ask whether an asset manager has an ESG policy any more because everyone is going to say that they do, said Alexis Cheang, partner for responsible investment at Mercer. She was speaking at the APAC Digital Symposium held by United Nations-supported non-government organisation, the Principles for Responsible Investment, on Tuesday (September 15).

Alexis Cheang, Mercer

“Ask them instead ‘how do you integrate ESG into the valuation process?’ ‘Show me some examples of where ESG has led to either new positions or larger positions than you would otherwise have taken in your portfolio?’ Or 'show me where you've determined not to invest or you've lowered the fair value target as a result of specific quantifiable ESG assessment metrics',” she said.

A metric that Kim Chong, head of risk management and compliance at HKMA, uses is to ask whether the fund managers are getting full management buy-in to include ESG issues.

“We focus on the commitment from senior management and preferably from the board. If it is driven from the top, that gives us a lot of confidence, and the results that come through speak volumes about their ESG commitments,” he said.

All the panelists on the session – 'Effectively incorporating ESG into the selection, appointment and monitoring of asset managers' – agreed not only that not having an ESG policy doesn’t cut it any more, but that a detailed and asset-specific approach to the issue is required.

A CERTAIN PRAGMATISM

HKMA’s Chong said that he looks for “idiosyncratic risk elements” in any portfolio such as a heavy carbon footprint and in those cases would ask asset managers what are they doing with those companies and what future plans they had.

“We look at their voting records,” he said, “even to understand why they always vote for management, especially if the resolution concerns ESG matters.

Kim Chong, HKMA

“[The asset managers] may have good reasons for voting in certain ways, [maybe] because they are already engaging with the companies themselves, and they have sufficient comfort that ESG has been looked after,” Chong said. He added that he meets with every general partner (GP) in person once or twice a year to see how they integrate ESG in the process.

A certain pragmatism is needed. Liza McDonald, head of responsible investment at Aware Super, formerly known as FirstState Super, highlighted that this was needed, especially with hedge funds.

“There's obviously a need from an overall strategy perspective to invest in hedge funds for a number of different reasons, whether it is liquidity or strategic,” she said.

However, it isn’t as simple as just rejecting a fund if it doesn’t integrate ESG.

“What we've tended to look for particularly [in cases of] derivatives or synthetic exposures… is alignment on issues,” said McDonald. “Are they [the hedge funds] willing to talk to us so that we can understand what they do and can we potentially work with them to improve some of the investment from an ESG perspective.”

POOLED FUND CHALLENGES

While a direct approach can be made with larger funds, it is more challenging with smaller or pooled funds.

“Getting the questions right when appointing a manager of a pooled fund is critically important. Obviously, you don't have the same level of control as you would have in an investment management agreement. But even in undertaking the search for a pooled fund, you can ask those questions and you can ask for those reporting metrics, upfront,” said Mercer's Cheang.

She mentioned a client in Australia who requires managers to attest on a quarterly basis that they have complied with the Modern Slavery Act – to account for how they address modern slavery risks and safer supply chains.

“That approach to attestation is interesting because it puts a legal burden on the investment manager to make true and fair disclosures back to the client,” she said.

It boils down, said Cheang, to whether asset managers share your approach to ESG.

“If you fundamentally believe that ESG is going to be a significant contributor to investment risk and return, then don't invest in asset managers who don't share that belief,” she said.