Case study: How Glenmede has created a sustainable and impact investing taxonomy to overcome ESG challenges

Mark Hays, Director of Sustainable & Impact Investing at Glenmede explores how to overcome some of the biggest challenges with ESG investing including a lack of clear terminology and perceptions that managers are greenwashing

Sara Benwell POSTED ON 4/1/2021 3:23:38 PM

Sara Benwell: What is the biggest challenge when it comes to ESG?

Mark Hays: ESG growth has been enormous across client segments and regions, but I think that the biggest challenge we see consistently from asset owners, is a lack of clear terminology.

SRI, green, impact, sustainable, responsible, mission-aligned: these are all terms that clients are getting hit with that are often used interchangeably.

Once they're past that confusion, it's this perception that there is greenwashing by managers. There’s a proliferation of products in the market that have ESG or impact in the title.

Sara: What are some of the ways to think about these problems?

Mark: We tackle it in in two stages. Firstly, we looked to develop a common terminology with the goal to divide the space into distinct approaches.

In our view, ESG is just a data set that enables you, as an investor, to look at environmental, social and governance risks.

As with any data set, there's lots of different ways to use it: as a complement to your traditional investment process; to design specific portfolios that exclude any ‘bad’ ESG companies in the portfolio or only include the best ones; to put ESG front and centre as the primary goal to produce measurable impact on the world.

"ESG is just a data set that enables you, as an investor, to look at environmental, social and governance risks."

These three approaches to the data are completely different, both in terms of investment goal and the level of impact created. Yet, right now, most players in the space are just saying, yes - we do ESG or yes - here are sustainable strategies. They’re all lumped together and that's not helpful.

We looked first at about 30 global peer firms, some bigger, some smaller in terms of how they categorised this space. We looked at Asia, Europe and the US to get a global viewpoint. Then we looked at some of the major databases and the large gatekeepers, like Morningstar and Evestment and some of the global consultants.

Lastly, and this might be the most important, we looked at the existing regulatory frameworks. If you look at the way Europe has approached this, they have the E.U. green taxonomy, which sets out a whole framework that asset managers are using right now.

"What we came up with is our sustainable and impact investing taxonomy."

It's a preview of what's to come in the US and we've even seen already some of the language in the U.S SEC. basically being lifted from Europe. This gives us a really good sense of the market.

What we came up with is our sustainable and impact investing taxonomy. This represents a spectrum of four distinct approaches to utilisng ESG to produce strong risk-adjusted returns and/or impact.

The first is ESG integration, where you're purely focused on returns and you're incorporating ESG where it's financially relevant and material.

"This is where you see most of the greenwashing happening"

This might not change your portfolio drastically. You could look at a very poor scoring ESG name, let’s say a traditional oil and gas company that hasn’t done much to think about the energy transition, but as an investor in an integrated approach, you're trying to assess if you’re compensated for taking on this ESG risk. As such, I might still invest in it. I might underweight it, I’m going to monitor it, but I might not just completely divest.

This is where you see most of the greenwashing happening. There are forms of it that are really strong and robust. And there are others where it is more lip service right now.

The second approach we call ESG mandated. These are strategies that use very specific screens. You are limiting your investment universe to either completely avoid companies with really poor ESG criteria or only want the ones with the best characteristics. You’re saying I care about risk and return absolutely first and foremost, but you are helping to contribute towards a problem such as climate change.

The third approach we call thematic. Here, not only are we going to look at ESG by negative or positive screens, we're going to target one specific goal. Through our portfolio, we're going to affect climate change. We're still targeting market rate returns, but right alongside, as an equal goal, we're targeting measurable impact.

"Where we've seen most of the growth by far is in that first approach, ESG integration"

The final approach is called concessionary high impact. Here, the primary goal is to achieve environmental or social impact above all else and you're willing to sacrifice returns to do so. This is that purest form of what used to be called impact investing.

We're seeing varying degrees of interest with these disciplines. But where we've seen most of the growth by far is in that first approach, ESG integration. That's where we're seeing the most questions from our clients asking us to help them understand all these managers that are suddenly telling us that they're integrated; what that means and how you evaluate who's doing it well. And that's where, again, greenwashing can be a problem.

Sara: How easy is it to communicate with clients about the impact that your investments are having in a way that's meaningful to them?

Mark: It's difficult in that it requires a high-touch personalised approach where you might have to iterate the specific impact goals you're targeting.

There's a cost associated with data, but it’s relatively easy to send an off the rack report of a manager or of a portfolio that says how you scored on ESG versus a benchmark. But how useful is that? Most clients don't come to us and say, I want to maximise the quantitative ESG score of my portfolio.

Typically, they say, I care about climate change and I want to understand how I can affect those areas.

We'll say, OK, you care about climate change, what is the way that you'd like to affect it? Is it by a ‘do no harm’ approach, where we measure their carbon footprint of the portfolio over time?

"Most clients don't come to us and say, I want to maximise the quantitative ESG score of my portfolio."

Or they do you want to be part of the leading impact solutions, aligned with the UN sustainability development goals. In that case, what we're measuring is the direct revenue contribution of your portfolio towards offsetting carbon. That's a totally different metric or a different way to achieve that goal.

Designing customised impact reporting as a way to meaningfully communicate with a client is what resonates.

This is different to a lot of managers right now. They'll say, yeah, the impact on our ESG score was six point two versus the benchmark of five point eight. Well, that's not all that meaningful in terms of the overarching goal. So that’s the key. It's personalisation, iteration and designing goals that fit with what a client is seeking to achieve.

Sara: To what extent do you think that asset managers need to align what they're saying they do from an investment perspective with what they they're doing from a company perspective?

This is a nuance that I think sometimes is overlooked. Asset managers could be caught out on this, where you present this beautiful, robust ESG integration process from an investment standpoint. And then a client says, well, what about you? Do you hold yourself to these same type of standards that you're holding underlying portfolio companies? And you don't want to be caught flat footed on that.

"Asset managers could be caught out on this"

For us, when we're trying to assess greenwashing of a manager, we are looking at the investment side - are you using ESG information in a repeatable, systemized way, as an input that is consistently applied in your core investment process? Show us the type of data you used, whether it's third party or your own. Tell us how you documented the way you look at that risk and how you're tracking it.

The other aspect that we are looking at is trying to assess how the firm overall thinks about its own ESG practices – their operational footprint from an environmental side.#

"When we're trying to assess greenwashing of a manager, we are looking at the investment side"

We’ve seen this all being amplified and elevated over the last year for a couple of reasons. Covid early on spurred a lot of questions around how investment managers are not just thinking about their clients and their shareholders, but also how they think about stakeholders, their employees and the broader community?

I think that the days are gone where you could say, look at this great ESG integration process that we have from an investment standpoint, but not have any of that thinking yourself as a firm. It needs to be looped together to produce a strong, integrated manager.

Sara: How are you approaching the lack of consistency, transparency and access to data?

Mark: The important thing for the investment managers we vet is to evaluate how they bring in diversified sets of ESG data and decide and understand which factors are the most financially material to investment decisions.

That goes for us as the overarching investment manager for our client base as well – in how we are able to provide tangible and actionable ways to measure ESG and impact progress in portfolios. 

We went through a lengthy vetting process of ESG and impact measurement providers understand what would be the most impactful for our client base – specifically in enable us to set clear, impact goals and monitor them going forward.

"We went through a lengthy vetting process of ESG and impact measurement providers"

If a client cares about climate change, we want to show them how they're doing but also be able to say, OK, if we were to make a change in the portfolio, here's the effect.

We ended up partnering with third party ESG and impact measurement firm that enables us to really grow our capabilities here. It was a mix of a very high quality ESG data provider in terms of the history and coverage of their data and also how they present it and how they link it back to impact outcomes.

That has been something that has resonated a lot with our client base already and we look forward to building upon.


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