Measuring the Managers: How the Asset Management Industry Integrates ESG
July 27, 2011 11:26 AM
The world of investment is changing: asset owners and managers have become increasingly aware of the potential risk and value impact of environmental, social, and governance (ESG) factors, and their potential effect on an investment profile.
The sudden impact of large scale events, many of which are not just caused by financial mismanagement per se, have lead to billions in aggregate lost retirement savings. The aftershocks of these events are steadily eroding aspects of the old guard’s traditional analytical framework, and the potential risks of ESG factors are becoming more widely recognized.
These developments have put more emphasis on the financial impact of ESG, and in this brief analysis, MSCI ESG Research aims to evaluate how ESG factors are being increasingly integrated into investment processes by the asset management industry.
Capital market responses to ESG events have steadily increased in magnitude over the past decade. We analyzed the average price momentum for a series of companies that experienced large scale ESG events over the last 30 years to understand the market’s pre- and post-ESG event reactions (see Figure 1).
On average, 5 years ago we saw a -4% share price change 8 weeks after an ESG event, with a volume spike of 44% from pre-event levels. Within the last 5 years, however, we saw a -33% share depreciation on average and a 450% jump in volume from pre-event levels. The results of our sampled analysis of environmental contaminations between 1980 and 2010 for ‘BP PLC’, ‘Tokyo Electric Power’, ‘Massey Energy’, ‘StatOil’, ‘Exxon Mobil’, ‘Conoco-Phillips’, ‘Chevron’, and ‘Royal Dutch Shell’ suggest a potential growing need for asset owners, particularly universal asset owners, to investigate the potential cost of internalized ESG risk in their portfolios.
Figure 1: Aggregate stock price movement pre- and post-ESG events for ‘BP PLC’, ‘Tokyo Electric Power’, ‘Massey Energy’, ‘StatOil’,’ Exxon Mobil’, ‘Conoco-Phillips’, ‘Chevron’, and ‘Royal Dutch Shell’ from 1980 to 2011; Source: MSCI ESG Research
While there is an increasing interest among many asset owners to incorporate ESG factors into risk analysis, the asset management industry has not fully responded to asset owners’ requests to evaluate ESG risk in their portfolios. For our recent MSCI ESG IVA Asset Management Industry Report, we developed a methodology to analyze the types of ESG risks embedded in each asset manager’s investment strategies and matched that against a set of ESG management best practices.
Our assets-at-ESG-risk model centers on two particular categories of risk for each asset manager’s clients’ assets: asset class and market. As an example, a private equity investment, given its long-only illiquid nature, increases the investor’s exposure to regulatory changes, ESG event risk, or even the long-term internalization of climate costs, such as weather severity and water scarcity regardless of industry or location. However, these baseline exposures are magnified in markets or regions that are particularly sensitive to ESG events such as India, where bio-capacitive resources (such as ‘water’ or ‘arable land’) are scarce. Our analysis utilized 4 indicators per asset class and 62 ESG risk data points for each country separated into four broad pillars (‘Financial Sustainability’, ‘Environmental Regulation’, ‘Geographic Constraints’, and ‘Governance & Political’) with the goal of modeling how an investment in a particular asset would be exposed to ESG risks in a particular market.
The strongest performing investment would be highly liquid with low transactional costs, and be located in a country or market with strong environmental policies, adequate bio-capacitive resources relative to its consumption, and a functioning government with limited corruption. The ‘radar charts’ (Figures 2 and 3) illustrate the risk differences between a top performer (‘Brazil’) and a bottom performer (‘China’), two Emerging Market countries with strikingly different country risk profiles.
Figure 2: ESG Risk Scores for Brazil Figure 3: ESG Risk Scores for China
We used this model to broadly assess how much ESG risk is underlying each asset manager’s assets under management, and each asset manager’s strategy to integrate ESG risks into the investment process was evaluated relative to the firm’s investment risk profile. We developed a set of management best practices for both passive and active managers, and then measured performance results.
The results demonstrated that managers based in the UK well outperformed their United States and global counterparts, having largely embraced ESG risks as material within various investment strategies. Excluding BlackRock, less than 25% of assets for US asset managers undergo any ESG risk analysis, with virtually no emphasis on integration. Our research shows that, of USD 6.9 trillion in client assets managed by US asset managers (excluding BlackRock’s USD 6 trillion in assets), nearly USD 5.2 trillion (or 82%) underwent little to no ESG risk analysis.
Presently, asset owner signatories to the United Nations Principles for Responsible Investing stand at 236 globally (an increase of more than 200% since 2007), and the two largest Californian pension funds (representing more than USD 380 billion collectively) announced this May that ESG integration will be required across all asset classes 1.
US asset managers aren’t just falling behind in managing ESG risks, they are also trailing in obtaining ESG mandates. The political aversion to climate regulation in the US has allowed European asset managers to gain opportunistic market share for ESG assets globally. According to State Street Global Advisors, European asset managers were responsible for more than USD 7.2 trillion of the estimate USD 10.9 trillion in ESG assets globally, with the US falling a distant second 2.
While events like ‘BP’s Deepwater Horizon’ catastrophe have garnered the lion’s share of investor attention on ESG issues, capital markets are increasingly punishing corporations that mismanage their ESG risks. If this trend continues, asset owners may increasingly search for managers who integrate ESG considerations into their investment processes.
For more information on ESG, please contact esgclientservice@msci.com or follow the links below:
Click here to find out more about 'ESG Integration' on our dedicated website
Click here to find out more about how MSCI ESG IVA facilitates 'ESG Integration'
Click here to receive more information on how to subscribe to MSCI ESG Research products and services
1 Source: ‘US pension giants make massive ESG commitments’: http://www.responsible-investor.com/home/article/us_pension_giants_make_massive_esg_commitments/
2 Source: ‘Sustainable Investing: Positioning for Long-Term Success’: http://www.statestreet.com/wps/wcm/connect/1f9fae8044624a16aa02eb27a2dfc506/Vision+Focus+Sustainable+Investing_FINAL.pdf?MOD=AJPERES&CONVERT_TO=url&CACHEID=1f9fae8044624a16aa02eb27a2dfc506