Hermes Investment Management, the £29.8 billion manager focused on delivering superior, sustainable, risk adjusted returns to its clients – responsibly, has today published the first in a four part series off the back of its second annual Responsible Capitalism survey. In the first paper, Responsible Capitalism and our Society, the results illustrate that while there is a growing awareness of environmental, social and governance (ESG) issues amongst institutional investors, this shift is not being reflected within investment decision-making.
The leading survey of over 100 institutional investors into responsible capitalism revealed a watershed moment in how institutional investors are embracing ESG. 78% of those surveyed believed fund managers should price in corporate governance risks as a core part of their investment analysis, alongside financial metrics. However, while investors are displaying a growing awareness that focussing purely on financial gains is not enough, the survey also shows a tendency to behave contrary to this.
Saker Nusseibeh, Chief Executive, Hermes Investment Management, said: “The results are remarkable when you consider fifteen years ago ESG was considered to be ‘out-of-the-box’ thinking. It is clear that ESG has become mainstream. However, the industry’s obsessive focus on measurement leads naturally to more short-term thinking and decisions that often miss the whole point of investment. This is to the detriment of the savers the industry is supposed to be serving.”
Growing awareness of ESG undermined by short-termism
The survey shows the level of awareness around the importance of ESG issues is definitely growing. Sixty-seven per cent of respondents consider significant ESG risks with financial implications as sufficient reasons to reject an otherwise attractive investment.
As our 2014 Responsible Capitalism survey found, reporting requirements such as IFRS17, the triennial valuation cycle and modern portfolio theory are driving pension schemes to think in short-term nominal returns, according to 44% of the survey respondents.
The result, Mr. Nusseibeh said, was ‘siloisation’, where investors see problems in the context of a single duty, such as making sure there is cash flow available when it needs to be paid out, and doing that in the most cost effective way.
The survey also shows that 58% of respondents believe the number of investment opportunities rejected by pension schemes because of ESG risks will increase only slightly over the next five years. Only 37% believe institutions should place a greater emphasis on quality-of-life factors.
Nusseibeh continued: “47% of respondents continue to believe pension funds should focus exclusively on maximising retirement incomes rather than giving greater consideration to whether their current investments will improve or detract from the overall quality of life experienced by beneficiaries when they retire”.
Passives are decreasing the ability of investors to effect change
Nusseibeh also pointed to the flow of assets into passive mandates as a headwind for the growing consideration of ESG issues by investment decision makers: “The opportunity for investors to effect change is quickly decreasing. By moving towards index-tracking strategies, investors are giving up their voting rights, and thus, their influence”.
This view is backed up by the report with 60% of respondents believe large shareholders are likely to ‘become unaware’ of the companies they invest in.
Nusseibeh said: “Many investors appear comfortable with this because of their primary objective of beating an inflation target. Risk-centric approaches to ESG and the inevitable decline in engagement born of the shift to passive are both symptoms of the same failing – measuring performance by the wrong benchmark.”
Antithesis of responsible capitalism
Despite the growing awareness of ESG issues, Nusseibeh said there is a ‘long road to walk before we see real change’:
“Financial services needs to address this and given the vital role that asset management plays in allocating the vast sums of savers’ money, it has a pivotal role to play in bringing about change in this regard.
“Today’s siloed and short-term investment approach is the antithesis of responsible capitalism. Change is necessary, if we are to ensure today’s savers and their children will be able to enjoy a fruitful world in the future,” Nusseibeh concluded.
Read the paper Responsible Capitalism and Our Society