ESG in listed equity – evolution or revolution?

ESG investing in listed equities has changed dramatically since 2017, when the PRI published its last snapshot on this asset class. These snapshots review and analyse the data provided by signatories in certain asset classes, providing a wealth of information about how ESG investing is changing. Over the last three years, we have seen our investor membership increase from 1500 to 2700, with the collective AUM almost doubling. The listed equity space has also experienced significant changes: passive strategies have grown exponentially and new financial instruments have developed. This blog outlines some key features of this data set around ESG integration and active ownership in listed equity.   

Unsurprisingly, listed equity remains the largest single asset class for our signatories across all regions and the asset class where signatories record a high percentage of A or A+ assessments in both integration and active ownership. ESG is broadly viewed as more mature in this space than many other asset classes. 

Like 2017, screening and integration remain the most prevalent approach to incorporating ESG practices into an investment strategy, and signatories reporting ‘no strategy’ has declined from 12% to 5% in 2020. The increasing use of independent audit bodies is notable as signatories increasingly undertake reviews of screening practices. Inevitably, larger and better resourced investment managers and asset owners were more likely to introduce these steps. There was a noticeable difference in approach between the two major capital centres. European signatories utilised screening (standalone and in combination with integration) more frequently than in the US where integration is the dominant strategy. Governance remains the mostly commonly researched issue when integrating ESG factors into an investment approach. 

Given that listed equities is still the largest asset class for investment manager signatories, the focus on improved reporting and active ownership has the potential to drive massive change in how managers extract further value from their portfolio holdings for the long-term

Mary Jane McQuillen, ClearBridge Investments, PRI Listed Equity Advisory Committee Member

 

 

The relative lack of ESG consideration in passive strategies…points to the continued importance of active investment management to asset owners concerned with environmental, social and governance issues.

Elizabeth Levy Member, Trillium, PRI Listed Equity Advisory Committee Member

The passive investing market has also changed materially since 2017. Passive assets now represent at least 45% of the S&P 500’s assets, with the number of ESG passive indices running into tens of thousands. The growth of ESG and passive have been key trends over this period. Despite this, nearly half of our signatories do not incorporate ‘any’ ESG factors into their passively managed assets. While this has dropped amongst signatories reporting since 2017, we still see 29% of those signatories continue to not incorporate ESG factors into passive strategies. 

As with ESG integration, when combined together it is evident that different aspects of governance – such as company leadership & executive remuneration – are the issues which signatories reported they engaged most frequently with portfolio holdings. Climate change was the most referenced single issue. 

There are some noticeable differences across the signatory base with asset owners putting a greater focus on climate change when compared to asset managers. Relative to Europe, diversity is a greater priority in the US. This survey was undertaken pre COVID – 19, so it will be interesting to see if social issues become more prominent in 2021. In 2020, the social issues that rank highly include labour practices & supply chain, diversity and human rights. One other noticeable feature was the exponential increase in the reference to the UN Sustainable Development Goals in the reporting responses since 2017.  

On climate reporting we have also seen some significant changes. In June 2017 we saw the publication of the final recommendations of the TCFD – just prior to the PRI’s last listed equity snapshot. Since then, these recommendations have provided a key framework for reporting on climate issues by investors and corporates. Despite progress across several of the TCFD’s core recommendations (governance, strategy and risk management), most signatories (71%) have not performed scenario analysis – a key step in the TCFD’s recommendation when integrating climate issues into investment practice. 

Signatories’ approach to engagement has also developed since 2017 – possibly the best example of new collaborations and approaches being the formation of Climate Action 100+ in December 2017. Involvement in collaborative engagements are on the rise, jumping from 68% to 83% among those reporting since 2017. However, there is a difference in the preferred engagement method between asset owners and asset managers. Asset owners are more receptive to collaboration, while asset managers prefer individual engagements. Larger asset managers are also more open to collaborative approaches. 

Sustainability transitions typically involve multi-year transformational processes…it is clear that the fund management industry must commit to a far more active and continuous level of long-term engagement to achieve authentic corporate sustainability progress.

Alex van der Velden, Ownership Capital, PRI Listed Equity Advisory Committee Member

Perceptions around divestment and voting rights also seem to have changed. The 2020 data shows that more than 50% of all signatories would consider divestment and over 75% of the largest signatories would consider voting against annual reports or directors as escalation strategies where engagement has been unsuccessful. We also see European asset managers report a greater openness to considering divestment as an escalation strategy compared with their US peers.  Larger signatories record a broader range of escalation strategies after unsuccessful engagements and have a greater ability to track these engagements. 

Signatories shared examples of engagement with a wide range of results, both positive and negative. Despite the examples being self-selected, just 22% of them resulted in some type of change by the investee company. After a process of engagement, the most common result was an improvement in disclosure or some other commitment.  The data allowed us to identify that the issues with the highest level of success among signatories were diversity and executive remuneration. Despite a small majority of signatories considering divestment as a viable option, it was a very unusual outcome of engagement – occurring in only 3% of signatory responses.  

Proxy voting is a key tool for listed equity investors. Unsurprisingly, as most of these issues are standard for AGMs, voting on governance issues dominates – with shareholder rights, board structure, remuneration, and company leadership being the leading ESG issues. We would expect voting on these issues to be a bare minimum level of activity. Climate change and diversity are the two ‘following’ social and environmental issues. Diversity is again the key issue among US signatories – provided as an ESG issue significantly more than European managers. Most signatories do not seem to have developed a next step – more than 60% have no escalation strategy after an unsuccessful vote. There is also little communication between managers and investees after votes against management recommendations. Notably, 26% of signatories reported that they followed up on an unsuccessful vote by contacting the board and 29% contacted senior management. Securities stock lending is another key area of focus in the reporting data - out of those who lend stock 13% of respondents do not recall stock to vote on shares. 

The marketplace for ESG products and responsible investment practices have developed enormously since 2017. However, this data does highlight some areas of ‘must do better’. Incorporation of ESG factors into passive strategies,  escalation strategies following failing engagements, improving the ‘strike rate’ on engagements, undertaking climate scenario analysis and following up with management teams after no votes, are all areas that sit in the ‘could do better’ bracket. We may see some interesting changes in this year’s data in a post-COVID 19 world. 

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].