Considering that they manage trillions of pounds, including our retirement savings, it’s surprising how little the average investor knows about asset managers.
We may be vaguely aware that asset managers – sometimes referred to as fund managers – are the people at financial institutions who invest money on our behalf. But they typically stay out of the spotlight as they go about overseeing the different investment funds into which our money is pooled.
However, amid talk about a more responsible form of capitalism and a growing demand for more sustainable and ethical products generally, the role of many asset managers – and the criteria they use for investing – is shifting. As well as focusing on financial returns, asset managers are also having to consider the wider social and environmental impact of the companies included in their investment funds. Investment funds are basically baskets of financial assets such as shares and bonds.
“The changing role of asset managers has been one of the most important changes in the [finance] industry during my career,” says Piers Hillier, chief investment officer at Royal London Asset Management, part of the Royal London Group.
He says that, increasingly, part of the asset manager’s role is to act as an “ethical guardian” – for instance, when it comes to assessing a company’s actions to address climate change and achieve net zero carbon emissions. New kinds of investment strategies and practices seek to “deliver the returns in a more responsible way” and “help [industry] get towards net zero”, he adds.
Moreover, asset managers aren’t just having to assess the environmental and social impact of the companies they invest in: there is also growing pressure on them to use their position and influence as sizeable shareholders to ensure that companies are run more ethically and transparently.
That pressure comes from a variety of actors, including individual investors and pension holders, pressure groups, governments and financial regulators. Some of the pressure is also self-imposed: asset managers increasingly realise that the damage wrought by climate change or boycotts by ethically-minded consumers can pose very real financial risks.
The upshot is that asset managers are now having to play a significant role in making the world a better place. That role is becoming more and more important as the fight against climate change becomes a global effort to reallocate resources and capital, and as governments take further regulatory steps to encourage the shift to a carbon-free economy.
“The whole investment landscape will change,” says Julia Dreblow, founder of both SRI Services and Fund EcoMarket, which provide information on sustainable investment. “Fund managers will have to show [that] they are playing a role in helping companies reduce carbon emissions.”
So how are asset managers achieving this – and providing proof of this to investors? One method is known as shareholder engagement. It’s a broad term for action ranging from informal and low-key discussions with companies to persuade them to improve their performance on environmental, social and governance (ESG) matters, to more confrontational measures, including tabling shareholder votes on ESG issues at annual company meetings.
“While we prefer the ‘carrot’ of engaging with companies to facilitate change, we also have the fairly large ‘stick’ of divestment,” says Hillier.
That stick can often be most effective when wielded collectively by asset managers who combine forces with other investment firms and shareholder activist groups to pressure companies into acting on ESG matters.
Of course, these new roles and priorities have also meant new kinds of challenges. For instance, asset managers have typically relied on robust and comparable financial data and accounting standards when measuring companies’ financial performance. But a current lack of universal standards and metrics for measuring and comparing companies’ performance on ESG issues means that asset managers have a much harder job when assessing a company’s carbon emissions and other ESG claims.
It can involve more qualitative judgement than quantitative analysis – which might mean they have to spend more time visiting companies and interrogating management. Asset managers might also struggle to gauge the motivation behind a company’s ESG policies and actions, or the impact of those actions on profits.
In addition, when it comes to questions of ethics and responsible behaviour, asset managers need to decide what should disqualify a particular company from being included in a responsible investment fund. For instance, what happens if a particular company is investing heavily in making a transition to cleaner and more ethical ways of operating but hasn’t quite got there yet? And which companies should you compare it with? In short, asset managers now face a raft of new and difficult dilemmas.
Stepping back from these specific dilemmas, asset managers also face a more fundamental shift in how they operate. Until recently, the two basic types of investment strategy have remained broadly unchanged. They are known as “passive” and “active”. A passive investment strategy seeks to minimise buying and selling by essentially tracking a stock market index, such as the UK’s FTSE 100 or the S&P 500 index in the US. In doing so, a passive investment fund tries to match the returns of the index it tracks. The amount of money a fund invests in each company will usually be in proportion to the company’s stock market value.
By contrast, an active investment strategy requires more work, judgment and action from the asset manager. Their investments, which may be more eclectic and take slightly more risks than passive funds, aim to provide better returns than passive funds that track the main share indexes.
However, this broad distinction between two types of investment strategy may be becoming outdated as asset managers increasingly use shareholder engagement both to assess companies’ environmental and social impacts and also to push for improvements. In short, it requires a more “active” investment approach, even for fund managers overseeing passive funds. Effectively, they become “active passive” fund managers.
“Research is showing that active passive managers are outperforming passive managers, even including the fees,” says Hillier.
Going forward, the efforts of governments and financial regulators to standardise measurements should help to make the ESG performance of different companies more easily comparable. For example, the Financial Conduct Authority (FCA), which regulates the UK financial services industry, recently announced plans to classify and label investment products based on their sustainability characteristics. It aims to agree standards for ethical investments to make it easier for investors to understand, while helping companies transition to a more sustainable future. The FCA has also said that it expects asset managers to play their part and give their views on the plans during a consultation.
As well as adhering to better regulations and improved standards, asset managers will also need to get better at communicating to investors what they are doing on ethical investment and what they want companies to do, says Dreblow.
They will also need to collaborate more. “Fund managers are deeply competitive by nature, but the seriousness of climate change … means that they have to work together,” says Dreblow. “If we are going to hit net zero we can’t have some fund managers saying [that] we don’t care what companies do [about ESG].”
Learn more about responsible investing by heading to Royal London – The Invested Generation
