Opinions expressed in AGB blogs are those of the authors and not necessarily those of the institutions that employ them or of AGB.
In this blog post, we’ll share best practices to help you integrate ESG risk factors into your investment portfolios. Regardless of the type of provider you’re working with, you as a fiduciary can rely on a variety of methods and strategies to express your beliefs within your investment program. These include (and are not limited to) active ownership, the consideration of ESG factors in manager selection, negative exclusions or positive screens, and directly hiring impact ESG managers. We’ll describe each of these methods in order of implementation ease and provide recommendations on how you might tailor these to your specific beliefs and circumstances. AGB also has resources to help members navigate ESG issues. Links to some are at the end of this blog.
Many higher education fiduciaries acknowledge and believe that ESG investing can benefit investment returns, reduce investment risks, align the portfolio with their institution’s vision, and address climate concerns raised by students and other stakeholders. Further, many fiduciaries also understand that there are a variety of ESG incorporation methods out there. The real question is—how do you begin to incorporate ESG into your portfolio?
The first step is to define your organization’s beliefs around ESG and, based on these, decide how much ESG your committee wants to incorporate. This decision should be guided by your organization’s ESG beliefs and goals, your comfort with a shifting regulatory arena, and your capacity for implementing different solutions. Below, we’ll explore several methods of ESG incorporation, in order of implementation ease, and describe best practices on how to incorporate these methods. Of course, each institution is unique, and these strategies should be tailored to meet your organization’s specific needs and situation.
1. Active ownership through proxy voting and/or company engagement
Active ownership is one of the easier approaches for fiduciaries to implement. It’s generally regarded as an effective mechanism to reduce ESG risks, maximize potential returns, and have a positive impact on society and the environment.
What is active ownership? It’s an opportunity for fiduciaries to have their voice heard and beliefs expressed within the companies they own within their portfolio. Fiduciaries should have a discussion about their beliefs and whether they want to engage in active ownership. Those organizations who have outsourced the management of their investment programs should share their beliefs with their provider and understand how their outsourcer is engaging on their behalf. For those with more direct control over their investments, proxy voting and/or company engagement can be a full-contact sport. Depending on bandwidth, fiduciaries can hire a proxy voting firm or stewardship service provider to manage this process, allowing your team to focus on only the most crucial ESG items. Fiduciaries can also assign staff to handle these engagement tasks directly. Regardless of your approach, it’s important to have a view on whether you want to engage in active ownership or not, and, if so, how you want to do it.
2. Consideration of a manager’s ESG credentials in manager selection/oversight
Think of this method as not limiting the investable universe of managers, but instead ensuring that you focus on hiring high-quality money managers that appropriately incorporate ESG factors into their process. Fiduciaries will want to make sure their investment consultant or OCIO provider has a clear methodology to understand how much ESG factors matter for a manager’s process. They will also need to ensure their provider is assessing each manager’s ESG capabilities, including the manager’s commitment to ESG organizationally and within the investment process, integration of ESG into portfolio decisions, and active ownership with portfolio companies to drive change.
Fiduciaries who are interested in incorporating more ESG elements into their portfolio will need a clear understanding of the importance of ESG to a manager’s process—meaning, if ESG factors are important to you, but not incorporated into the processes your managers follow, there could be a mismatch in priorities within your portfolio. We recommend assessing these ESG factors in your manager selection and oversight processes. Incorporating them at this stage can help fiduciaries better understand which specific ESG factors their managers are focused on. This, in turn, can help improve return potential and lower portfolio risk.
3. Incorporating negative ESG exclusions or positive ESG screens
Some fiduciaries may have specific beliefs on how to improve portfolio performance and/or align with their views by excluding or including certain stocks for ESG reasons. Common exclusions include environmental activities (e.g., animal testing or fossil fuels), governance practices (e.g. corruption levels), and social issues (e.g. gambling or tobacco). Meanwhile, common positive ESG screens—or factors that you may want to have more exposure to—could be stocks of companies that are expected to benefit from a transition to renewable energy or that have high employee satisfaction scores.
Whether you’re working with commingled fund managers, separate account mandates, or OCIO mandates, fiduciaries have different ways of incorporating exclusions or positive ESG screens. Fiduciaries should share their beliefs with their service providers and work with them to model the potential impacts of specific ESG inclusions or exclusions so they fully understand the impact these decisions may have on their investment portfolio.
4. Hiring impact or sustainable ESG managers
Hiring impact or sustainable ESG managers is probably one of the more difficult strategies to implement when it comes to bolstering your ESG incorporation efforts—but it’s also likely the best way to move the needle more toward ESG in your investment portfolio. To hire impact or sustainable ESG managers, we believe fiduciaries should determine what themes they want to target and what types of funds they would like to utilize, and work with their service providers to find and hire best-in-class managers that meet their desired themes and fund structures.
The bottom line
These best practices on how to incorporate more ESG into your investment program should be tailored to your specific beliefs, circumstances, and reporting capabilities. For many higher education fiduciaries, it probably makes sense to use a combination of these methods. However, concerns about how to incorporate more ESG should not stop your from gaining the multitude of potential benefits of greater ESG incorporation. Work with your service providers to explain the outcomes you’re looking to achieve so they can provide you with the right guidance to help you find the best path forward.
Albert Lim, CFA is a Consultant for Russell Investment Consulting Services.
References and Resources
- 2021 FLF SESSION: Mission Aligned Investing – A Roadmap to Responsible Investing
- 2021 FLF SESSION: The Financial Case for Mission-Aligned Investing
- AGB PUBLICATION: Endowment Management for Higher Education (Book)