Using environmental, social, and governance (ESG) factors to evaluate investments in companies has in recent years become increasingly popular and controversial. One of the most notable and influential initiatives for ESG investing is the United Nations Principles for Responsible Investment (PRI), created in 2006. Asset managers signing on to PRI commit to incorporating ESG into their portfolio decision-making and also to actively monitoring their investment. By 2019, the total assets under management (AUM) of signatories worldwide have grown from just a few hundred-billion dollars to more than $90 trillion – almost three times the market capitalization of companies in the United States.
PRI encourages compliance with the following six principles: 1) incorporate ESG into investment analysis and decision-making, 2) be active owners and incorporate ESG into ownership policies and practices, 3) seek appropriate disclosure on ESG issues from companies receiving an investment, 4) promote acceptance and implementation of PRI within the investment industry, 5) work to enhance the effectiveness in implementing PRI, and 6) report on activities and progress towards implementing PRI.
To sign on to the PRI, a senior executive of the investment management firm executes a declaration form, committing the firm to comply voluntarily with the principles, pay a nominal annual membership fee, and publicly report on its responsible investment activity through a UN-guided framework. According to the UN’s PRI website in 2019, the only mandatory requirement is the public. In addition, signatories are asked to have an investment policy that covers more than half their AUM and specifies their responsible investment approaches, the internal and external staff responsible for implementing those approaches, who at a senior-level is responsible for the commitment, and how they will hold the firm accountable for keeping the commitment. Failure to meet these guidelines over a two-year period, following extensive engagement with the PRI, would result in delisting.
In a recent paper, we analyze U.S. asset managers’ commitments to ESG using UN PRI as a setting. We know very little about whether asset managers’ compliance with PRI is being monitored or whether asset managers are meeting their commitments. We focus on active managers (not ETFs or index funds).
The level of professed interest in and commitment to ESG and PRI would suggest that investment professionals have made substantial changes to their portfolios and actively incorporated ESG into their decision-making. This expectation is natural because the PRI commitment is signed by senior executives who set their firm’s direction and are concerned about their own reputation (Benkhoff, 1997). However, there are reasons to expect otherwise. First, funds that sign PRI may already be using ESG factors and strongly committed to the success of ESG investing. There is no reason to expect their ESG performance to improve. Second, ESG is hard to quantify, and there are disagreements about how to measure its use (Berg et al., 2019; Christensen et al., 2019; Khan et al., 2016). For example, the 2017 CFA Institute Survey found that more than half of the surveyed asset managers did not receive any ESG-related training and complained about the lack of quantitative ESG information. In such cases, asset managers may not have a clear sense of how to incorporate ESG into their portfolios. Third, there could simply be a lack of demand from clients for ESG. For example, half of the professionals who responded to the CFA Institute Survey said clients showed little demand for ESG investing and deemed ESG issues to be financially immaterial. Fourth, the execution of UN PRI is subjective and largely voluntary (Cheng et al., 2019).
We find that there is a very significant increase (4.3 percent per quarter for the six quarters after signing PRI) in the capital allocated to signatories that committed to incorporate ESG. We find this increase regardless of prior fund-level ESG performance. We examine fund-level ESG scores of the PRI funds and find no evidence of improvement. In addition, PRI signatories exhibit a notable decrease in fund-level return. Our finding is robust to using a battery of different ESG dimensions from various data vendors. Further, we find that signatory funds vote less on environmental issues and that stocks in their portfolio experience more environmental controversies post signing. We also look at cross-sectional characteristics and find that institution-only funds and quant-driven funds are more likely to improve fund-level ESG performance. However, other fund characteristics do not drive meaningful changes in ESG. Overall, we conclude that only select funds improve ESG while many others use the PRI status to attract capital without notable changes to ESG.
Our findings have important implications. First, they suggest a need for a systematic way to measure and assess how asset managers execute ESG. We view this as important in light of the increasing amount of capital being committed to ESG and relevant for policy makers and the UN PRI itself to protect the welfare or investors. Second, our paper calls for asset owners to more effectively monitor investment managers allocate capital to funds that claiming engage in ESG investing. Finally, our paper suggests that asset managers need to be more transparent about how they use ESG factors.
This post comes to us from professors Soohun Kim at the Georgia Institute of Technology’s Scheller College of Business and Aaron S. Yoon at Northwestern University’s Kellogg School of Management. It is based on their recent article, “Analyzing Active Managers’ Commitment to ESG: Evidence from United Nations Principles for Responsible Investment,” available here.