What do fund managers focus on in ESG funds?
There is hardly a week these days without another survey of investors or fund managers and their attitudes towards ESG investing. However, a recent survey by researchers from the University of Otago, New Zealand, caught my eye because they asked what themes fund managers emphasised when integrating ESG into their portfolios.
They asked 44 fund managers, in Australia, New Zealand, the United States, and a few other countries about their attitudes towards ESG investing. The top line results are roughly what you see in all of these surveys. 81% of fund managers think that ESG information is material to the investment performance of a company and 74% said they used ESG information because of growing demand from clients.
But there are interesting regional differences. 71% of Australian and New Zealand fund managers as well as 83% of European fund managers said that incorporating ESG into their investment process will encourage companies to change their ESG practices, but only 33% of American fund managers did so. Also, two out of three Australian/NZ fund managers and half the European fund managers said that ESG investing was an ethical imperative, i.e. “the right thing to do”, but only 11% of fund managers in the United States. This shows once again the large difference between Americans and the rest of the world in this space. In the United States, fiduciary duty by the fund manager is still defined as making the highest return for a given level of risk, and the dominant attitude towards companies is one of shareholder value maximisation. Meanwhile, in the rest of the world, stakeholder value maximisation has taken over as the dominant management theory of the firm and as a result, fund managers focus not just on the returns companies generate for shareholders but the how companies manage all their stakeholders.
But as I said in the beginning, the interesting results of this survey are the views of fund managers on the most important topics in the ESG space. To elicit these themes, fund managers were asked if they focus on a specific ESG theme and then given the opportunity to weigh the different topics. Below is a summary of the answers.
Importance of ESG themes to fund managers
Source: MacLean et al. (2022)
Climate change clearly is the most important topic for fund managers and if you ask fund managers of ESG funds the emphasis on climate change is even bigger. Climate change is also more important in Europe and the UK than it is in the United States or in Australia and New Zealand.
Meanwhile, for conventional fund managers, the most important theme is corporate governance and corporate behaviour, though this is still the second most important topic for ESG fund managers and the second most important topic overall. This confirms my experience with fund managers that corporate governance is something like a gateway drug for ESG investing. Most investors realise that good governance is crucial for the long-term profitability of a company, so they have long focused on corporate behaviour and governance. Now that it is packaged within the ESG framework, they are happy to use this kind of analysis to start giving these topics a bigger weight.
A few other things I noticed in this survey. First, I am surprised by the relatively low weight given to human capital. We live in a knowledge society and human capital is arguably the most important driver of profitability for most companies today. Yet, an analysis of good management of human capital and companies treating their employees well is not very high up the agenda of investors. This is also visible in the relatively low importance given to health & safety issues. Whether this is because human capital management is harder to assess and put into numbers than a company’s impact on climate change or whether investors simply don’t realise how powerful good human capital management is, I don’t know. But I think investors need to emphasise human capital more in their ESG approaches.
The second thing I noticed in the survey results is the gap between the topics emphasised in the press and the topics that matter to fund managers. If you read the newspapers, you will often find sensationalist articles about the excessive remuneration of corporate executives or about the lack of diversity on corporate boards. For fund managers, such diversity and remuneration topics rank rather low on the scale of important ESG topics. At least when it comes to diversity, I think fund managers don’t realise the proven benefits of having a more diverse board. Though that is impossible because I have written about it so often that by now every fund manager in the world must know these benefits. Alas, there still are a handful of fund managers who don’t read these missives, much to their detriment.
Overall, fund managers seem to emphasise the E and G in the ESG, but struggle with the S, even though the S is arguably the most important component of ESG.