PRI calls for academics to fill ESG research gaps

Responsible investment research has reached a “tipping point” in its development, says the PRI’s director of strategic development, Rob Lake, and it needs to be more closely aligned to the practical needs of front-line investors.

Lake – who joined the UN-backed Principles for Responsible Investment (PRI) in May this year from Dutch asset manager APG, where he was the head of sustainability and governance – recently attended his first PRI Academic Network conference, held in Sweden.

While research into responsible investment has grown exponentially in the past five years, it still needs to better address the needs of practitioners and to broaden its scope, he says.

“There is now some really valuable academic work being done and, inevitably, there is some work being done that is less valuable to practitioners,” Lake says.

“Like a lot of things to do with ESG [environmental, social, corporate governance], we have been through the first couple of waves and there is a tipping point now where you can see the value of what has been done so far, and you can see how to improve it into the future.”

Lake says a lot of this “first generation work” has focused on what he calls “aggregate ESG ratings”, which seek to provide ESG rankings on the performance of individual stocks in a portfolio.

This body of work is valuable in demonstrating that an investor can generate alpha by systematically taking ESG factors into account, he says.

But it does not reflect the needs of investors or fit into the way they operate when making investment decisions.

“Just looking at things in terms of high level company ratings is not actually the way that practising portfolio managers work most of the time,” Lake says. “They are interested in fundamental drivers of company value rather than high-level aggregate views of a company overall.”

Front-line managers are becoming more interested in “specific indicators and data points linked to fundamental drivers of asset value” than aggregate ratings, Lake says.

In a recent article published on the PRI’s website, he has called for more research that focuses on identifying these fundamental drivers of return and risk.

Lake came away from the Academic Network conference impressed by the vitality and energy of research. But he was also left with the impression that some academic research is far removed from the practicalities of front-line investing; and he has outlined areas where he feels there is room for improvement.

These would cover the five key areas in which the Academic Network works: investment and strategy, engagement, public policy, organisations and market structures.

He makes the point that the body of ESG research currently available focuses mainly on the equity asset class, and notes that at the conference there was not a single paper on ESG/sustainability and sovereign bonds.

This is despite the world economy being gripped by the worst sovereign debt crisis in a decade.

Lake says there is an urgent need for more ESG research across all asset classes, particularly in light of some asset owners moving away from equities.

When it comes to research on how ESG can be integrated into investment decision-making and strategy, Lake says more work needs to be done on looking at how the consideration of ESG factors can work in diverse investment strategies and styles.

This would include looking at areas such as fundamental stock picking, passive indices, quant and top-down thematic investment styles.

While ESG research has focused on equities, Lake also sees room for more research on how ESG can be integrated into strategic asset allocation decisions, where he says little work has been done.

In fact, Lake says ESG should look to be more strategic in its focus, and attempt to address “big picture” issues, including the impacts of externalities, such as climate change, on large diversified portfolios, and the changing structures and governance of global capital markets.

He challenges ESG researchers to broaden their focus to meet the needs of investors who, after the financial crisis, have realised that they need to consider a broader range of macroeconomic, social and political questions when making investments.

One of the aims of the Academic Network is to facilitate collaboration between academics in different fields, but Lake says that it is not only finance specialists who are well placed to provide insight into ESG integration.

“Actually there is a lot of material to play with here and a lot for academics to get to grips with; and academics from a lot of different disciplines can play a really important role,” he says.

“It just not the finance people within business schools that have a part to play.”

Interdisciplinary research is needed across a broad range of fields, with Lake identifying management, psychology and anthropology as some of the areas of knowledge that could contribute to ESG research.

Questions regarding such things as managing sovereign risk or how best to integrate ESG considerations into the complex organisational structures that are pension funds would require answers drawn from a broad selection of expertise.

“ESG people don’t quite realise how broad their own agenda is; and the ‘G’ in ESG, people think of 99.9 per cent of the time as being about corporate governance in listed companies,” he says.

“But the sovereign debt crisis is a problem of governance – but it is a crisis in the governance of countries.”

Lake says that the aim of the Academic Network is not to direct or prescribe research areas but to facilitate and encourage academic research that is relevant to investors.