Assessing external managers and service providers

Delegating engagement and voting activities might be the only option for small and resource-constrained organisations or highly diversified investors. In some countries, large asset owners are also banned to engage by law as they hold a large portion of the local economy and could be market movers.

When active ownership practices and asset management services are outsourced to the same entities, investors will need to pay close attention to the relationship between engagement/voting activities and investment decisions. When these practices are delegated to a third party that is not involved in the investment decision-making process, gathering information on the insights from active ownership and sharing it with portfolio managers is fundamental. Finally, when engagement and voting activities are outsourced to more than one entity, it is important to develop an active ownership policy which defines expectations and frameworks of reference for third parties to use to ensure consistency of messages to investee companies.

Selection and appointment

During the selection process, investors can collect information on the current and past performance of investment managers and service providers on active ownership through:

• responses to a formal RfP;
• responses to the PRI Reporting Framework, available on the PRI website or through the PRI Data Portal (see box);
• PRI Assessment Reports through the PRI Data Portal;
• publicly-available statements or reports on the application of national stewardship codes and access to relevant assessments if available;
• publicly-available responsible investment/engagement/ voting reports;
• meetings and site visits with representatives (i.e. portfolio managers and ESG specialists) from potential investment managers/service providers; and
• talking to peers.

In this reviewing phase, an investor needs to evaluate the third party’s:

• Active ownership policy: A good policy would cover the elements specified in Chapter 1 and would be aligned with its internal policy; if of interest, the investor might assess if the organisation can execute activities following a specific client fs policy.
• Capacity and governance: Both engagement and voting activities require adequate resources, skills and oversight/commitment from the top.
• Engagement process and outcome: There should be evidence of a solid process to research and prioritise activities in addition to information on ESG outcomes and eventual financial performance achieved through active ownership activities.
• Investment decision-making process: There should be an explanation of how active ownership activities feed into the investment decision-making process (for investment managers only).
• Reporting capacity: The organisation should demonstrate the ability to provide information on active ownership activities on the format, quality and frequency expected.

Once the investment manager or service provider has been selected, the investor can decide to include specific active ownership requirements in the contract. Typical specifications refer to active ownership objectives and reporting obligations. Some investors prefer to retain voting rights and include relevant language in the contracts. Including specific text in investment and service provider agreements can facilitate the monitoring process and hold the third party accountable for its services. A side letter to the investment management agreement could be an alternative solution as it forms a legally-enforceable understanding between two parties and provides a formal record of the client’s wishes and the investment manager’s intention to abide by them.

Including requirements in contracts and side letters is not the only way to ensure sound outsourced active ownership practices; following a thorough selection and monitoring process is equally as effective.

Evaluating and monitoring 

An evaluation of investment managers’ and service providers’ active ownership practices can be made through regular reporting, meetings and surveys/questionnaires. Measuring the ESG performance of portfolios held externally is another way to engage with investment managers. For example, some investors have used the results of external mandates’ portfolio carbon footprint to discuss climate change engagement programmes and voting decisions with their investment managers. Regular discussions with third parties can also focus on aligning the outsourced engagement programme or voting activities with the investor’s internal engagement and voting policies. More generally, information requests during the monitoring process can be very similar to those considered during the selection process, although the conversation with external parties will be more focused on assessing the impact of active ownership activities on ESG outcomes and financial decisions.

Regular monitoring meetings should focus on:

• any changes to policies, resourcing or processes in place at the time of selection;
• understanding if there has been any material changes to the ESG risks and opportunities in the portfolio;
• the depth and breadth of internal and external ESG research used;
• current training to improve staff ESG competency;
• controversial or material ESG topics raised/to be raised during engagement dialogue or considered/to be considered during the voting season;
• the rationale for engagement discussions and voting decisions and alignment or deviation from the investor fs investment beliefs/strategy and agreed policies of reference;
• the companies selected for engagement;
• the frequency/intensity and quality of interactions with companies;
• the objectives, progress, outcomes and next steps of specific engagements;
• participation in collaborative engagements;
• the investor’s direct participation in some engagement activities or alignment between dialogues held in-house and those conducted by the investment manager/ service provider;
• examples of how any eventual conflicts of interest have been managed;
• percentage of voting decisions reviewed in-house and percentage of portfolio voted on;
• outcomes of any voting audit checking whether votes were cast as intended and reached the companies; and
• implications of active ownership activities on investment decisions and impact on the portfolio’s level of risk or return over time.

Investors might meet with appointed investment managers and service providers regularly to follow up on information received through reports. The discussion could also be part of regular financial performance meetings in cases where asset management activities are outsourced to investment managers. As general best practice, the monitoring process should involve the investor’s ESG/responsible investment teams and the investment teams to communicate with one voice and avoid duplication of inquiries. Internal appraisals and scorecards through the use of questionnaires and surveys can help investors provide regular and constructive feedback to investment managers and service providers and to inform decisions on retention and allocation rebalancing.