Asset owners need to spell out mandate details for ESG integration

In a discussion on the changing relationship between asset owners and managers when it comes to integrating ESG, panellists including PGGM’s Arjen Pasma at this year’s PRI Digital Conference emphasised the importance of collaboration, long-term goals and being very specific in mandates.

Arjen Pasma, chief risk and compliance officer at PGGM Investments which has around 50 per cent of its €266 billion ($322 billion) portfolio with external managers including large private market allocations, said success of ESG integration with managers depends on specific details within the mandate, and asset owners reiterating their long-term objectives.

At the same time, he warned against asset owners placing tight restrictions on their managers as it will impede performance.

“It’s about being specific about the type of behaviour you want from the manager and the type of voting you like,” he said, adding that specifics should include compensation, alignment of interests and details on how managers should report.

Mandates should also include specifics on collaboration and shared endeavour around, for example, sharing data and engagement.

“Our AUM isn’t huge; it is only possible to achieve by partnering with others.”

In Australia, the balance of power between asset owners and managers has shifted to asset owners increasingly shaping and driving mandates said Angela Emslie, a member of A$56 billion HESTA’s impact committee. Given the sophistication and influence of the country’s vast super funds collectively managing some $3.3 trillion, asset owners now call the shots when it comes to integrating ESG into mandates.

“They are mandate makers not takers; if asset owners can’t get what they want, they will internalise investment management,” she said, speaking during a debate at PRI Digital.

Still, Australia’s asset owners haven’t always wielded the power. Emslie said that when HESTA first engaged with managers on sustainability some 20 years ago, the conversation only centred on the fund’s fiduciary duty to members and beneficiaries as stewards of their capital. Conversations on voting and ethics and the need for long-term sustainable investment followed, as did selecting and monitoring managers on ESG. Now the conversation is about building a bridge to real world outcomes, she said.

“The evolution of responsible investment has sped up over the last 18 months. It’s an idea whose time has come. ESG is mainstream and asset owners who don’t take it seriously are left behind and open to operational risk.”

Signs of change

Fellow panellist Sara Bernow, partner at McKinsey & Company agreed mandates once framed around risk and return now take into account responsible investment, sustainability and the expectations of all stakeholders. Transparency and ESG performance have become central to mandates. She noted how asset owners and managers are collaborating in this space and customizing mandates, creating specific and tailored investments that take asset owners sustainability preferences into account.

“We see innovation and partnership in this space.”

Panellists reflected on the need to “empower” asset owners in their relationships with asset managers, demanding ESG progress and holding them to account.

Collaboration

Collaboration between owners and managers was a key theme picked up by panellists. Doug McMurdo, chair of the United Kingdom’s Local Authority Pension Fund Forum, the industry body for the eight pooled funds with a combined £350 billion assets under management, said local authority funds had shown the power of collaboration in the investor backlash to Rio Tinto’s destruction of a an Aboriginal site in Western Australia that resulted in senior executives at the company stepping down.

In another collaboration, local authority pension funds are now working with Brazilian asset managers to address dam failures, putting pressure on Brazil’s mining sector.

PGGM’s Pasma added that collaboration ensures a bigger seat at the table, resulting in better engagement, particularly evident in private equity.

“Not so long ago it was very hard to negotiate anything in terms of ESG in private equity; now private equity firms are opening up.”

He said the industry should also come together to help shape regulatory change. “The last thing we want is 35 different reporting standards.”

Tensions

But panellists acknowledged tension in the relationship. Asset owners need to ensure asset managers are proactively moving on engagement and stewardship and delivering financial value to underlying beneficiaries for the long term. McMurdo voiced his concern that asset managers are still acting in the short term in a conflict with pension funds long term priorities.

Moreover, he said that “all too often” financial institutions and companies use the TCFD as a “cover,” not giving asset owners the information they need.

Another block to effective asset owner engagement with managers lies in the fact many funds have large passive allocations.

“You can’t do effective engagement with 4000 companies; how can you give these companies enough attention? If you want to engage, you need to rethink about how you invest your money,” said PGGM’s Pasma, highlighting that many Dutch funds have large passive allocations.

He suggested asset owners work with fewer external managers.

“Don’t partner with 300, partner with 100.”

He also advised on investing time in strategic relationships forged around beliefs, risk tolerance and a clear delineation of roles between the asset owner and manger.

At PGGM, the current focus is on getting the right ESG governance internally with trustees that can then align with asset managers. Pasma noted caution amongst trustees to engage around ESG, yet said being “a good ESG investor” involves taking an active stance, shaping active policies and accepting risk. Both trustees and asset owners need to step up and be more transparent, he said.

“You can’t hide behind benchmarks.”

HESTA’s Emslie noted that asset managers are still primarily incentivised around alpha. Rather than thinking about “what the world does to companies” she urged managers to think about “what companies do to the world.”