NEW YORK, Aug 2 (LPC) - Asset managers are increasingly making sustainable investment decisions that reflect their own corporate values and those of their investors, but are still under pressure to deliver competitive returns as the market continues to develop and implement environmentally friendly principles.
Many of the largest money managers including Neuberger Berman, BlackRock and PIMCO have dedicated environmental, social and governance (ESG) guidelines for their own investments, and are also balancing requests from their investors, including pension funds, endowment and family offices, to limit investments in industries including gun makers, fossil fuels and healthcare.
Asset managers face dilemmas in implementing ESG guidelines as to where to draw the line on sustainable values, as green lending principles continue to gather momentum in the institutional world.
“It’s really complicated to establish moral principles for other people’s money,” said Karen Petrou, a co-founder of consulting firm Federal Financial Analytics. “Once you get past businesses that are clearly illegal—it gets a lot trickier in businesses and areas that are legal that you just don’t like.”
Financial markets are becoming increasingly focused on ESG principles. Bank of England Governor Mark Carney warned earlier this year that once climate change becomes a “clear and present danger to financial stability” it could already be too late.
Some firms have established protocols including internal ESG company rankings that include a report of every borrower engagement and a list of steps being taken to remedy potential concerns.
But other managers are sitting on the sidelines as ESG investing continues to develop, due to concerns that proscriptive rules could limit investment opportunities.
Credit managers report that as specific requests from their investors increase, they are being forced to reconsider investments that would not previously have rung alarm bells.
Several managers pointed to the extended life cycle of an investment. While a manufacturer that makes parts may not raise concerns, if those parts could be installed in helicopters that are sold to the US Department of Defense, it could trigger prohibitions against investments in ammunition and guns.
The risks embedded in supply chains are also a concern for manufacturers that are attempting to adhere to ethical guidelines due to potential exposure to natural resource depletion, human rights abuses and corruption.
Some firms looking to establish ESG protocols are trying to set strict quantification for guidelines and develop indices that rely on them, according to Scott Mather, chief investment officer US core strategies at PIMCO.
“That’s certainly better than doing nothing, but in our view that has some major flaws too because it’s difficult for people to do a one-size fits all, and draw the line here for this company versus that company,” he said.
The Newport Beach, California-based asset manager, which oversees US$1.84trn, has its own internal ESG rating system which is used in its dedicated ESG funds, but is available to all of its funds. Although the firm looks at all available data, the final investment decision comes down to human judgment, he said.
“We rely on our analysts to decipher where to strike that balance,” Mather said.
Proponents of ESG-focused investments point to the environmental benefits that sustainable investing can promote, but also highlight the positive impact on the bottom line as ethical capital is attracted to the funds.
Riskier sub-investment-grade companies have less margin for error due to their indebted balance sheets so Neuberger Berman’s evaluation of ESG factors helps identify tail risks before they materialize in a company’s operations, said Christopher Kocinski senior portfolio manager for non-investment grade credit at the New York-based manager that oversees US$333bn.
Neuberger Berman has evaluated ESG factors for more than 20 years and assigns scores to issuers that it invests in based on management quality and governance framework.
“We think that as we go through a full market cycle that, that will improve the overall quality of our portfolio and improve our return profile,” he said.
While financial institutions are setting their own ESG standards, Congress has tried to legislate to better help investors assess climate risks.
Presidential hopeful Senator Elizabeth Warren, and several co-sponsors, in July introduced the Climate Risk Disclosure Act of 2019, which would require public companies to disclose their exposure to climate-related risks.
On the other side of the aisle, Republican Senator Kevin Cramer and co-sponsors proposed the Freedom Financing Act earlier this year, which would effectively block banks from refusing to make loans to businesses engaged in activities that are considered socially controversial by cutting off their access to the Federal Reserve’s discount window.
The bill followed limits on lending to the gun industry by banks including Citigroup that followed a wave of mass shootings in the US.
With competing pressures, asset managers say ESG discussions are continuing to evolve, but are set to play an increasing role in investment decisions.
“One of the challenges of ESG is it means different things to different people,” said John Vibert, head of structured products at PGIM Fixed Income. “It’s the building principles that have been a long-standing part of our process, but have gotten more solidified and more codified under ESG more recently.” (Reporting by Kristen Haunss. Editing by Michelle Sierra and Tessa Walsh)