The Law Commission has spoken, but barriers remain to ESG growth

Internationally the number of schemes that made a commitment to responsible investment has soared, but has that really made a difference to the way money is invested?

The UN-supported Principles for Responsible Investment has more than 1,260 signatories with more than $45tn (£26.7tn) assets under management. In the UK alone there are 182 signatories, including 39 asset owners.

If the success of responsible investment is defined by the engagement from institutions then this has been successful so far. However, if its success is defined by actual outcomes, such as changes in the way capital is allocated and investments are made, then this must be further explored. 

An increasing number of pension schemes – both in the UK and internationally – are evaluating the responsible investment capabilities of asset managers in their requests for proposal, as well as security selection and portfolio construction skills.

In turn, fund managers are committing to responsible investment and integrating financially material ESG issues into their investment decisions across strategies and asset classes, including pooled fund products.

This trend gives trustees of smaller schemes the choice to adopt responsible investment policy when appointing investment or fiduciary managers.

Smaller pension schemes can also pool their resources and use an overlay engagement service, proving that responsible investment is not only for the larger schemes with more resources, but can be implemented by all schemes.

Changing your perspective

ESG issues such as good corporate governance, strong environmental performance and the treatment of workers are set to be more material in the medium and longer term, while currently investment horizons are still focused on the short term.

A call for long-term investment has to be matched by additional measures that remove the existing incentives for short-termism

The same Law Commission report criticised the current investment landscape, stating that trustees are not expected to maximise short-term returns at the expense of longer-term risks.

But is the shift towards responsible investment matched by an equal shift from short to long-term investment horizons and, if so, does that also apply for smaller schemes?

Despite the claim that ESG issues should trigger a longer-term focus, the current landscape provides numerous incentives for short-term investment decisions.

This is one of the reasons the PRI started a group to investigate the possible measures to overcome short-term barriers and promote longer-term investment as an integral part of responsible investment.  

With the growing awareness of ESG and the increasing understanding of its long-term financial benefits, we expect it to continue to become a key investment element for pension schemes, just as evaluating company specifics and market risks are today.

However, the barriers for implementation are still abundant.

Problematic coverage ratios, peer pressure and the restrictions caused by a dominance of thinking in terms of benchmarks and tracking errors, are all incentives for short-term alpha strategies. 

Other barriers stem from the pressure of regulators and oversight bodies to increase the liquidity of portfolios. There is also reluctance from politicians to develop a binding international agreement on climate change that can set the rules to enable investments in sustainable solutions.

For smaller pension schemes the challenges are even greater. Size matters when investors seek to access the instruments of responsible, long-term investment such as effective engagement strategies, infrastructure and private equity.

The emerging trend towards fiduciary management makes necessary collaboration accessible and provides some answers. 

But a call for long-term investment has to be matched by additional measures that remove the existing incentives for short-termism, and make structural changes to create a landscape where responsible investors can shift from managing short-term ESG risks to investing in long-term sustainable solutions. 

Narina Mnatsakanian is senior adviser of responsible investment and governance at fiduciary manager MN