Mainstreaming Responsible Investment - AccountAbility

Responsible Investment Futures
An underlying, further need is to develop and implement
acceptable performance assessment models that enable
trustees to support long-term investment strategies while
complying with their fiduciary responsibilities. These long-term
performance models are beginning to emerge, often
underpinning funds with a corporate governance focus, and
sometimes associated with funds with explicit non-financial (as
well as financial) aims. However, to date these have remained
largely marginal to the bulk of fund management strategies
and practices.
The basis on which such strategies and practices evolve
needs to become a key competitive edge for fund managers.
One way to encourage this is for trustees and other capital
providers to demand performance benchmarks that
distinguish between sources of return underlying fund
management strategies and practices. While benchmarks will
differ widely, a useful underlying starting point may be to
establish benchmarks that separate portfolio performance into
three fundamental sources of return: (1) dividends; (2) earnings
(that portion which is not paid out in the form of dividends);
and (3) valuation changes (of the company). Distinguishing
among these fundamental elements of return can be very
useful from a trustee’s perspective, in that it reveals much
about fund managers’ investment processes. Over long
periods of time, “income” oriented managers, for example,
should show a pattern of high returns from dividends and
lower returns from the remaining two factors. Similarly, “value”
oriented managers should show a balance between returns
from dividends and those from changes in companies’
valuations, as companies’ presumably healthier-than-expected
business prospects become recognized in the market-place.
“Growth” oriented managers should show very little returns
from dividends, and much more earnings growth and changes
in valuations 69 .
“Operationalizing” the next generation of performance
benchmarks, focused on the longer term, would have to be
done in conjunction with a number of other initiatives; for
example:
transparency, to capital providers, of investment strategies
in adopted practice, including the actual proxy voting
behaviour by fund managers;
disclosure of information, as increasingly demanded in the
US, about the relationship between rewards to both the
investment house and individual fund managers, and the
proposed basis for driving and benchmarking full-term fund
performance.
Shifts in pension fund mandates with realigned incentives are
necessary but not sufficient to mainstream responsible
investment. Clearly, the ability of mainstream analysts and fund
managers to factor in social and environmental issues requires
them to, first and foremost, understand them. In the last two
decades, the development of equity analysis has focused
largely on developing financial expertise, anticipating corporate
events and establishing valuation benchmarks. Competency
revolves around the interpretation of accounts, the analysis of
structural position and the development of discounted cash
flow valuation models. Analysis of non-financial criteria has
remained thin where it exists, focused mainly on “quality of
management”.
There has been some increased understanding of social and
environmental issues by the growing number of analysts and
fund managers working alongside specialist SRI teams.
However, this growing appreciation has been mitigated by the
weakness of data, and the focus of analysts and fund
managers’ clients on shorter-term variables. For this reason,
the development of appropriate competencies will in all
likelihood be market-driven on the back of changing client
needs. Fund managers would be required to demonstrate, in
responses to Requests for Proposals, their skills in longer-term
investment strategies. And they, in turn, demand very different
research from analysts, which drives a competency shift in this
part of the investment value network.
There would be a need, however, to develop a more effective
means of assessing and attesting to the competencies of key
players. This would be particularly important in the early
stages for investment houses, since their competencies will
(more than previously) underpin their bids for fund
management deals. Over time, however, this may become
less important as more investment houses build up a track
record in successful, longer-term investment management.
Taken together, this package of proposals, further developed
and implemented, would encourage pension fund trustees
and other capital stewards to request proposals from fund
managers that, to be successful, would require:
investment strategies linked to longer-term
performance benchmarks;
incentives demonstrably aligned to such performance;
a clearly established basis of relevant and adequate
competencies on the part of the fund management team to
effectively implement the proposed investment strategy.
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