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How passive investors can actively embrace ESG
VIEWPOINT – Asset owners in Asia-Pacific who are seeking to begin or deepen their ESG engagement are now able to work with their passive manager to get active in creating sustainable value, says Kevin Anderson, head of investments, Asia-Pacific, for State Street Global Advisors.
Kevin Anderson 27 Jul 2017
Kevin Anderson is head of investments, Asia-Pacific, for State Street Global Advisors.
Kevin Anderson is head of investments, Asia-Pacific, for State Street Global Advisors.

A growing number of global investors are aligning their portfolios with their views on environmental, social and governance (ESG) issues. For many, it’s about excluding investments that are not in keeping with their missions. Yet, 90% of asset owners in Asia-Pacific aspire to go deeper than negative screening to achieve fuller integration of ESG into their overall investment strategy in the next two years, according to a recent survey by SSGA.

Asset owners in Asia-Pacific who are seeking to begin or deepen their ESG engagement are now able to work with their passive manager to get active in creating sustainable value. Effective and active stewardship aimed at engaging with companies in the index on issues that potentially affect their ability to generate the attractive, long-term returns is a key attribute in managing investments.

Focus on the long-term
Active managers can sell companies when they disagree with the companies’ management, but passive managers represent near permanent capital that will stay invested for the long term. As long as a company remains in an index, it remains in the portfolio of a passive investor and it is precisely that long-term ownership which should focus passive investors to be actively influencing those companies.

Unlike with many active investors who may have shorter term goals, we believe that active engagement rather than adversarial interaction, or simply passive inaction, is the most effective approach for passive investors to achieving sustainable value. Through patient and consistent engagement, using voice and vote, passive investors can drive focus towards longer term matters and promote positive long-term change.

Effective, independent board leadership
In an earlier survey conducted by State Street’s Center for Applied Research, ‘governance’ was cited as the most important individual component of ESG factored into APAC institutional investors’ investment process. In fact, if there’s no adequate governance, companies are less likely to be able to create outcomes, which are also good for the ‘E’ and ‘S’. It is well-understood by asset owners in the region that good governance, with a strong risk management programme, is just a start which leads into the others.

As such, a key focus of active stewardship is ensuring that boards have the right skills and diversity of thought to help management articulate and execute a long-term strategy and have the independence to hold management accountable. A strong and effective board committed to the long-term is more likely to lead to attractive results. It is also probably the most effective counterweight to the many short-term pressures that markets and other forces exert on company management.

Guidance on ESG issues
Passive investors’ engagement goes beyond just voting at board meetings; it is a two-way street and so passive investors should provide maximum transparency to its portfolio companies around their views, expectations and voting policies. It is great to see that asset managers are increasingly working with asset owners to create principles aimed at promoting good governance and protecting shareholder interests, an example of which is a multi-year collaboration of asset owners and managers that culminated in a set of comprehensive stewardship and governance principles as part of the Investor Stewardship Group (for more details click here).

Large global passive investors have a top-down vantage point across industries and countries on the kinds of ESG risks and opportunities that might affect long-term value. Leveraging this unique perspective, we have proposed a series of questions that boards can use to begin to incorporate sustainability lens into their long-term strategy, such as:
• Has the company identified the sustainability issues material to the business?
• Has the company analyzed and incorporated sustainability issues, where relevant, into its long-terms strategy?
• Does the company consider long-term sustainability trends in capital allocation decisions?
• Is the board equipped to adequately evaluate and oversee the sustainability aspects of the company’s long-term strategy?
• Does the company’s reporting clearly articulate the influence of sustainable issues on strategy?
• Is the board incorporating key sustainability drivers into performance evaluation and compensation programmes?

Using these insights, passive managers categorize a company’s progress and assess their approach to sustainability, and in turn decide the issues and companies to focus on in order to maximize impact.

Asset owners have options
Despite the increased ESG adoption worldwide, the proportion of an institutional portfolio’s assets with ESG exposure remains low. This is especially noticeable in APAC where only 15% of surveyed institutional investors have at least half of their assets exposed to ESG factors. And our survey findings point to cost as the top challenge inhibiting greater ESG adoption in the region.

But the good news is, as asset owners are increasingly allocating to passive assets to minimize cost and make their portfolio work harder, it is still possible to create sustainable value through their passive manager’s asset stewardship.

By working with passive managers who participate in active stewardship, asset owners can influence companies towards creating a more prosperous future, and in turn generate more sustainable long-term returns that asset owners need to fulfill their objectives and fiduciary obligations.

Kevin Anderson is head of investments, Asia-Pacific, for State Street Global Advisors.

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