Behind the curve: still a long way to go on SRI

When the head of Google Eric Schmidt dismissed criticism of his company’s ‘immoral’ tax avoidance policies as ‘just capitalism’, the behaviour of the world’s largest corporations was cause for scrutiny once again.

“The investment management industry as a whole needs to be more proactive and engaged on the whole question of what it really means to be a responsible investor.”

Vincent Neate

Like the bloated executive pay packages before it, tax avoidance is the latest example of poor corporate behaviour which, while legal, highlights the need for institutional investors to play their part in curbing dubious business practice.

Reaction from the UK government makes clear it does not believe enough is being done by investors to encourage good behaviour while driving out the bad. In March this year, Sir George Cox conducted an independent review on behalf of the Labour Party into short-termism by British business. Among his conclusions Cox said UK institutions, including pension funds, asset managers and insurance companies, were failing to take their shareholder responsibilities seriously and there was a “vacuum at the heart of the UK’s corporate governance system”.

Cox’s findings followed those of the Kay Review in 2012, a coalition government commissioned review of UK equity markets and long-term decision making, which also highlighted failings in corporate governance and called for investors to improve best practice and transparency.

To help pension funds shoulder this additional burden, in May the National Association of Pension Funds (NAPF) launched a guide to responsible investment.

Updating its earlier 2009 guidance, the NAPF says the document supports pension funds in their environmental, social and governance (ESG) duties, and helps ensure their asset managers are also behaving appropriately. David Paterson, head of corporate governance at the NAPF, says pension funds should make responsible investment the norm. “[Pension funds] should develop clear policies that reflect ESG factors in decision-making, and exercise stewardship responsibilities such as engagement and voting,” Paterson says.

But the fact is incorporating ESG is not the norm for the majority of pension funds. The 2013 Mercer European Asset Allocation survey found schemes that actively incorporate ESG issues into their investment operations “tend to be large and well-resourced” and noted that “trustees generally have limited experience in assessing ESG issues from an investment perspective and limited time in which to improve their knowledge”.

Just 50% of the European pension funds surveyed by Mercer are devoting time in trustee meetings to discussing ESG issues.

Of course there are several well-known funds in the UK that excel in responsible investments. The Environment Agency, the Universities Superannuation Scheme and many of the local authority pension funds have impressive ESG policies in place. However, these are multi-million, in some cases billion, pound plans with the resources and motivation to take ESG on in-house.

For every other scheme ESG is largely outsourced to intermediaries such as asset managers and investment consultants who are critical to ensuring investors meet their responsible investment obligations.

Paterson says: “It is vital to select investment managers that act as responsible investors and report clearly, and to then hold them to account.”

Room for improvement

However, there is a question mark over the competency and commitment of some intermediaries in delivering a responsible investment strategy.

Vincent Neate, head of climate change and sustainability at KMPG, believes fund managers are behind the curve on responsible investment.

He says: “My sense is that the investment management industry as a whole needs to be more proactive and engaged on the whole question of what it really means to be a responsible investor.”

Meanwhile Will Oulton, global head of responsible investment at First State, says investment consultants are still developing their responsible investment credentials.

“Many [UK] pension funds don’t have that [stronger governance] capacity and so they are wholly reliant on the advice and decisions of investment consultants. Investment consultants are still building their own capacity and knowledge in terms of understanding responsible investment and how that benefits their clients’ long-term interests and objectives,” Oulton says.

And Paterson’s point about the imperative to monitor investment managers may be easier said than done. The Kay Review makes clear the difficulties facing trustees in overseeing their intermediaries and asks: “The question of who guards the guards is inevitably followed by the question of who guards the guards who guard the guards.”