Active management can identify companies that are more sustainable Investors want nuanced understanding of ESG risks Higher financial valuation of companies must compensate for the ESG risks Robust research has always been essential to active managers. Today, they have to look beyond a company’s balance sheet and consider non-financial drivers of its business success to truly understand its sustainability and whether it is worth investing in the long term. Active management can identify companies that are more sustainable Active managers are able to look into companies and industry operations, as well as management. They can use all the available information, including non-financial information, to determine what they believe could potentially have a material impact on those companies. We are convinced that sustainable investing through environmental, social and governance (ESG) integration, proxy voting and engagement improves an active manager’s ability to identify those investment opportunities that offer sustainable, long-term competitive advantages. If we look at the bigger picture and the transition towards a more sustainable society, active managers can be a part of the transition mechanism between capital markets and the real economy by helping to deploy capital with sustainability in mind. We believe that active managers have an important role to play as stewards of capital, especially in terms of value chain of consumers, companies, asset owners, governments, etc. They are an important catalyst for the adoption of sustainability in a number of areas, including education, disclosure, stewardship and collaboration. Investors want nuanced understanding of ESG risks We believe that some of the easy wins in sustainability have already been achieved. Given the trend towards more sophisticated and divergent sustainability goals and objectives, an active approach is useful for analysing and understanding the materiality of issues, such as the knock-on effect on supply chains. Both passive and active managers have an important role to play in realising the potential value that thoughtful engagement and proxy voting can add. While large passive managers have the size to influence voting on broad issues, their scale can hinder their ability to achieve nuanced engagements with companies. Conversely, active management can be more fragmented. Active investors with deep research capabilities are able to perform “materiality discovery”, similar to price discovery, and proactively engage with investee companies to instigate change. We believe that sustainable investing through ESG integration, proxy voting and engagement improves a managers’ ability to achieve the clients’ objectives and meet fiduciary responsibility.Active managers generally have higher coverage ratios of analysts per company, allowing the analysts to truly understand the businesses. While passive managers get a seat at the table, their inability to divest renders them with less bargaining power. Passive managers tend to be less active in collective engagements, only recently have they stepped up their game. Investors are looking for a longer-term, sustained improvement in material ESG areas that are relevant to a given company. While transparency and measurement are important, we caution against an overreliance on narrow or blunt measurement tools, which cannot be expected to capture the nuance and range of the ESG risks and opportunities faced by companies. Higher financial valuation of companies must compensate for the ESG risks Active managers consider factors that they believe could affect investment outcomes. When an ESG-related risk is highly material to an investment, it is heavily weighted in the decision-making process. Any risk or opportunity that is not expected to have a significant impact immediately, needs to be reviewed periodically to ensure that it has not grown in importance. In assessing a case where the valuation is attractive but a sustainability factor is not, it is critical to understand if the poor ESG factor is material to the business, it would be useful to engage with the company prior to investing to understand the reasons for the ESG deficiency, assess whether the company is making improvements and evaluate if the financials compensate for the ESG risk. The next ten years will be crucial to achieving the challenging goals set out in the Paris accord. The effects of climate change are becoming more financially apparent, and the idea of planetary boundaries will become a regular part of conversations and investment theses. We believe that active ownership will become a necessity and the norm for all managers, both active and passive. There is a possibility that passive owners, not only passive managers, will be penalised if they don’t use their voting power to build more sustainable practices at companies. Firms involved in greenwashing will be exposed with increasing data transparency and standardisation of metrics. For a more sustainable planet, investors will play a key role, and so will active managers. Vishal Hindocha is the global head of sustainability and Dan Popielarski is the associate analyst at MFS Investment Management which is an asset management firm based in UK. Views and opinions expressed in this opinion editorial belong strictly to the authors/contributors and do not reflect that of Wealth and Society.
