Designing investment mandates for real-world outcomes

As part of the PRI Digital Conference, we hosted two webinars on the relationship between asset owners (AOs) and investment managers (IMs)—looking at fund governance and mandate design. The events touched on the challenges and opportunities in the implementation of responsible investment commitments. This blog reflects on key takeaways from those webinars. With COP26 seeing a raft of increasingly public and ambitious climate commitments made by both asset owners and investment managers, these webinars provide a timely reminder about the challenges and mechanics of how those commitments are put into action.  

Investment mandates 

One of the key talking points at both sessions was around the investment mandate: the framework that maps out the expectations AOs have when they allocate capital to IMs. AO panellists at these sessions clearly outlined that if managers are to be held accountable for implementing their increasing expectations on reporting, climate targets and real-world outcomes, then there is a need for clear objectives laid out in contractual arrangements, including investment mandates. The PRI believes that responsible investment and a focus on real-world outcomes should be a central element of the relationship between AOs and IMs.  

Responsible investment should be at the core of the relationship between asset owners and investment managers. More and more clients want it, regulators demand it and academic & industry evidence supports it. This is the starting point that explains why our work on selection, appointment and monitoring (SAM) is so crucial.

Fiona Reynolds (PRI) 

The implication of this is that the “traditional” elements of mandates—portfolio construction, fee structures, voting practices, compensation and reporting expectations—all need to be continuously reviewed and refreshed in the context of these changing ambitions. That of course, is easier said than done. Different regulatory frameworks and interpretations of fiduciary duty all make a standard global approach difficult. For some AOs, designing new mandates is unusual so the focus might need to be on reviewing existing contractual relationships.  

The sessions at the PRI Digital Conference, our paper on selection, appointment and monitoring of external managers, and PRI reporting data point to mandates being an underutilised tool in helping asset owners signal their expectations. Those expectations might be about translating sustainability objectives into outcomes through mechanisms such as portfolio design, monitoring and stewardship practices. These events highlighted that the industry has taken two different approaches on mandates: identifying a set of minimum standards and formalising them into new mandates, and incorporating ESG expectations into legacy mandates. 

In practice, minimum expectations of a mandate include the integration of material ESG factors into asset selection or portfolio construction, an action that is aligned with fiduciary duty. Adaption of contractual relationships includes a range of steps, such as incorporating ESG provisions into side letters or outlining expectations around issues such as manager diversity and real-world outcomes through the selection or monitoring process. 

Real-world outcomes 

The focus on real world outcomes has really been brought to light in the rush to make commitments around net zero—especially over the last month during COP26. The challenge for asset owners is how these commitments can be formalised into sets of instructions or expectations to investment managers. 

Our interviews with asset owners in our paper on embedding ESG factors into investment mandates highlighted several common steps in taking action to achieve real-world outcomes: learning and measuring; target setting; and promoting outcomes. Target setting and measuring involved developing mechanisms to incorporate the SDGs into key performance indicators; measuring positive and negative portfolio outcomes; and comparing over time or against peers.  

Transferring measurement and target setting into actions to promote real-world outcomes has often resulted in a dual strategy with our interviewees: intentionally allocating capital in ways that help achieve the outcome, and engaging collaboratively or individually with investees, policy makers and regulators. Our paper has some great examples of these types of actions from the Government Pension Investment Fund (GPIF), New York City Retirement Systems and CalPERS. 

In reality, development of investment mandates to promote real-world outcomes remains in its early stages. One reason for this discussed during the sessions was around the lack of managers with dedicated strategies where real-world outcomes are a specified objective. 

Fund governance 

The session we ran on fund governance brought many of these threads together and reminded us that transferring a responsible investment policy into contractual arrangements—such as investment mandates—is only one tool among a range of options. The operating environment for these tools to work effectively needs to be an alignment of incentives and governance between the board of trustees and external managers. Both parties need to be clear about the objectives, expectations and limitations. 

Where this alignment is in place, AOs have a solid foundation to incorporate RI expectations into investment mandates to address systemic issues and to collaborate rather than to focus solely on incorporation of material ESG issues and minimum standards. 

This blog is written by PRI staff members and guest contributors. Our goal is to contribute to the broader debate around topical issues and to help showcase some of our research and other work that we undertake in support of our signatories.Please note that although you can expect to find some posts here that broadly accord with the PRI’s official views, the blog authors write in their individual capacity and there is no “house view”. Nor do the views and opinions expressed on this blog constitute financial or other professional advice.If you have any questions, please contact us at [email protected].