Outsourcing ESG methodology no longer enough

Asset managers will need to take greater ownership of environmental, social, and governance (ESG) exclusionary processes, as oversight of ESG investing tightens, according to State Street Global Advisors (SSGA).

SSGA’s latest ESG report said that while exclusions had become more widely used, many institutions had come to rely on third party ESG data providers for screens of topics they wished to exclude.

However, investors were beginning to question the data and methodology powering the exclusionary lists.

“The increased scrutiny of all ESG investment products by both regulators and activists, in 2020, we expect it to become increasingly untenable for investors to fully outsource their exclusionary screening methodologies and keep their involvement at arm’s length,” SSGA said.

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It noted that the choice of a data provider’s methodology and which companies were included in their overall universe could have direct and differentiated impacts on a portfolio.

The report also said ESG strategies would become more complex as investors were beginning to set multiple ESG objectives within their portfolios.

“For example, fully eliminating exposure to certain sectors while minimizing exposure to underperforming companies and also setting broad emissions reduction targets across the portfolio,” it said.

This, it said, had implications for both portfolio construction and product development.

“The increased incorporation of ESG into index portfolio construction will further mainstream ESG investing within active strategies,” SSGA said.

“This along with the evolving understanding of fiduciary responsibility means that active managers who do not incorporate ESG into their company due diligence and investment processes will need to explain why they don’t see ESG as a portfolio risk or investment opportunity.

“Investable products, too, will respond to investors’ evolving ESG goals. We expect to see the methodologies of existing product suites being updated to reflect multiple ESG objectives, and a growth in new investable solutions to meet the variety of more complex demands emerging in the market.”