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November 17th, 2020

Environmental, Social, and Corporate Governance (ESG) Analysis and its Ascent in the U.S. Institutional Investment Industry

By Scott Treacy, CFA

Environmental, social, and corporate governance (ESG) analysis and its ability to highlight investment risks has brought it to the fore for U.S. institutional investors. This institutional market evolution has been led by those people in charge of the plan assets, the asset owners. More and more large U.S. institutional asset owners are signing up for the United Nations Principles for Responsible Investment (UN PRI) to promote the six principles of responsible investing (UN PRI – Six Investment Principles). As a result, countless U.S. asset management firms are scrambling to modify their investment evaluation process to ensure ESG analysis is incorporated. The increased emphasis placed on ESG analysis by U.S. institutional investors has led to many structural changes at U.S. based asset management firms.

Of the close to 600 UN PRI signatories located in the U.S., close to 10% are asset owners. Over the past five years we have seen the U.S. asset owner figure rapidly grow from 22 to 52 UN PRI signatories. These U.S. signatories manage over $1.54 trillion (Pensions&Investments data)[1] in plan assets with the largest plans being CalPERS, CalSTRS, and New York State Common Fund. Some of the more recent signatories include Minnesota State Board, Los Angeles City Employees Retirement System (LACERS), and the Employees’ Retirement System of the State of Hawaii. Many U.S. plans are also incorporating ESG analysis language into their investment policy statements (IPS). As a result, they are demanding more transparency on how ESG analysis is being incorporated by the active asset managers that invest their assets.

[1] Pensions&Investments, https://www.pionline.com/

Facing mounting pressure from asset owners over the past few years, active asset managers have heavily invested in the implementation of ESG analysis in their overall stock evaluation process. The Investment Metrics Market Research Team reviewed eighty-two active equity asset managers to see how they incorporate ESG analysis at their firm. One of the most significant changes we’ve seen in the near-term is the fact that 95% of the firms are now UN PRI signatories (up from 83% in 2019). Furthermore, over a third of the asset managers have someone who is the “Head of ESG.” Their responsibility is to develop ESG strategy, outline the firm’s approach to ESG analysis, and to ensure this analysis is being incorporated in the overall investment process. Also, close to half of the firms reviewed purchase third-party research (MSCI, Sustainalytics, Bloomberg, Asset4, Trucost, and many more) for ESG ratings of companies to help their investment analysts monitor and incorporate those risks. Some of the early signatories of the UN PRI were JP Morgan Asset Management (2007), ClearBridge Investments (2008), and Acadian (2009). More recent signatories include Bridgewater Associates (2020), Tweedy Browne (2020), and Guggenheim Partners (2020).

One of the largest investments asset managers have made over the past few years is to allocate resources towards staffing dedicated ESG teams. We were able to find the number of dedicated ESG analysts for 72 of the 82 firms we reviewed. The sample had a range of 90, an average of 13, and a median of 3. Those asset managers at the high end of the dedicated ESG analyst spectrum pulled the average figure higher. However, most of the sample offered a tally closer to the median number of 3 dedicated ESG analysts. Those asset managers at the top include Generation Investment Management (90), Clearbridge Investments (67), and Impax (55).

Clearly, the participants in the U.S. institutional investment market place are positioning themselves to incorporate ESG analysis for the long-term. More asset owners are realizing that ESG analysis is able to detect possible investment risk and seem convinced that sustainable investing is here to stay. They are demanding that those active asset managers investing their plan assets are also trying to identify those risks. Therefore, asset managers are looking to structure their firms to ensure ESG analysis is being utilized so they can keep and win assets. Many are doing this by designating a person who is responsible for ESG oversight and hiring a team of dedicated ESG analysts to provide research. This welcome investment trend in the U.S. institutional investment industry will provide a more well-rounded investment evaluation and, ultimately, protect plan assets.

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