The complexity of sustainable investing could be a step too far for many asset owners with current governance not up to the complexity of embedding environmental, social and governance (ESG) factors into decision-making, according to head of Towers Watson Roger Urwin.
The comments come as the global asset consultant is set to release the results of Project Telos, a collaborative project spearheaded by Urwin and done in conjunction with Oxford University.
Also partnering on the project were 22 investment management partners and eight chief investment officers. The global CIO group included Mohammed El Erian of Pimco, Jim O’Neil from Goldman Sachs Asset Management, Adrian Orr from New Zealand Super and Jaap van Dam from PGGM Investments.
Streamlining complexity
Urwin says that the Project Telos aims to provide a road map to sustainable investing as a way of streamlining the challenging complexity of integrating sustainability considerations into asset owner decision-making.
“Telos is trying to help organisations to take on a new strategy when often the governance they would have to move to that new approach would be super-stretched by this type of change,” Urwin says.
“The governance of asset owners across the world is not strong. I didn’t say weak and that is important. Because in some respects to be too negative about asset-owner governance is to lose track of the difficulties that asset owners have in managing complex funds in the fast-moving financial markets of today.”
Having been at the coal face of fund governance, working with some of the world’s biggest asset owners on improving their decision-making processes, Urwin says that sustainability demands funds ask big questions beyond traditional investment approaches.
It also brings into the spotlight what he describes as the “governance gap” between the existing levels of fund governance and the demands of managing an increasingly complex investment landscape.
Clarifying a “worldview” and a set of beliefs around investment at the board level is crucial to starting down the path of sustainable investment.
Urwin says that sustainable investing has become more justifiable than ever from a “finance first” point of view.
For Towers Watson this involves a definition of sustainable investing that encompasses long-term investing that is efficient – as measured by return per unit of risk.
Sustainable investing also entails intergenerational fairness: “We measure that by the terms of the deal for present, current participants being as good as the returns enjoyed by future participants of a fund,” Urwin notes.
While the detailed findings of Project Telos have not yet been released publically, Urwin says the project aims to provide road map covering key areas from drawing up sustainable investing mandates to managing risk exposures to ESG factors.
“It is a cute phrase, but funds don’t have the bandwidth to deal with sustainable investing at the moment,” he says.
“That is why Towers Watson is helping funds to embed sustainable investing within the investment process, and a change management process around road maps is the best shot at the task.”
Transformational change
The work done in Project Telos involves thinking about “transformational changes” and positioning portfolios with a view to how these changes will affect investment performance over the medium to long term.
Towers Watson identifies three transformational changes involving slowing growth in developing economies; the changing demography and the declining work force in developed countries and China; and resource scarcity and the pressure it will put on natural capital.
According to Urwin, traditional investment approaches look to gradually plan for the future on a year-by-year basis, while sustainable investing demands fiduciaries form a view that takes into consideration some of the key risks that can have a material effect on portfolios.
It is an approach that attempts to position a portfolio both for today’s conditions and simultaneously for what the future may hold, Urwin explains.
Starting with a clearly defined set of investment beliefs and worldview, a fund could take the step of committing to the UN-backed Principles of Responsible Investment (PRI) as part of starting the process of embracing sustainability.
Urwin describes this process as “emblematic” and “only one piece of the whole”. Asset owners also have to roll up their sleeves and get down to the nitty gritty of looking at their manager line-up and how to construct mandates that reward a long-term focus.
This would involve an integrated assessment to look at sustainability practices.
“Sustainability encompasses ESG exposures, it’s a portfolio assessment, it’s a process assessment but it also encompasses the economics of the relationship, the fees in the relationship, the benchmarks used,” Urwin says.
Part of this process is a “de-emphasis” on the role of cap-weighted benchmarks as a measure of performance, with a greater focus put on absolute returns over long periods of time.
Using the navigation principle of triangulation as an analogy, Urwin says that an emphasis on outcomes is a way of “getting a fix on a manager from two lines of sight”.
Moving from a relative benchmark to incorporating absolute-return objectives requires substantial governance work, according to Urwin.
“Benchmarks drive portfolios; bad benchmarks drive bad portfolios. This principle is being applied here. So the driving force behind portfolio construction is an outcome more than a relative-to-benchmark position – that type of point is a key part of the sustainability conversation,” he says.
Another clear signpost on the road map is funds thinking about their exposures to certain sustainability themes.
As part of this, traditional notions of asset allocation are expanded to include so-called smart-beta, in which investors use both specific mandates and asset-allocation decisions to capture exposures to a variety of ESG-related themes.
Urwin points to ESG-weighted indices as an example of a fast-growing selection of investment tools to measure and give exposure to ESG factors.
Finally, the road map also encourages an expanded role for the notion of ownership responsibility, encompassing asset owners as not just investors, but advocates for a broader range of issues.
“Asset owners and asset managers as their agents must have a much more developed view of their ownership responsibility, particularly in respect to the major causes of our time,” Urwin says.
“So, examples will include the oversight of the banking sector and their externalities, oversight of companies with environmental responsibilities and influence on important societal questions such as corporate pay.”
Urwin says that Project Telos has grappled with the question of fiduciary obligation, explaining that the road map is underpinned by an “enlightened view” of what constitutes fiduciary duty.
He says members now expect their fiduciaries to address issues such as executive compensation or environmental concerns.
