Stockholm (NordSIP) – As low costs and performance continue to increase the popularity of passive investments, ESG integrated versions of passive funds have also grown in popularity. However, hurdles remain according to a new report by the UN Principles for Responsible Investment (PRI).
Passive Concerns: Data Quality and Index Picking
Signatories to the PRI’s six principles of sustainable investment noted that data quality and availability are perennial concerns for responsible investors. Following a discussion paper and two industry events during which it surveyed its members, the PRI has now published a report with its findings.
Most issues – such as data availability, standardisation, reliance on voluntary reporting, and the backwards-looking nature of ESG data – are not unique to the passive investment market, but were flagged by participants. Consistency and availability of corporate data, in particular, were perceived as the biggest challenges facing PRI signatories. They also discussed the potential role of regulators in designing and constructing benchmarks.
Deciding on a benchmark index to compare passive performance was also described as a difficult choice. According to the report, “this decision might include incorporating ESG factors into the construction of these indexes or benchmarks. Here, challenges exist around index complexity, index and fund transparency, and how to compare between ESG indexes.”
Engagement and Active Ownership
Surveyees also highlighted the need for more collaborative engagement among passive investors to facilitate active ownership. According to the PRI, signatories reported that asset owners need to encourage the largest passive asset managers to undertake corporate engagement. Lack of research and resources was a point of contention for everyone, but mainly for the smaller members.
According to the report, “participants identified the need for asset owners to encourage the largest passive asset managers to undertake corporate engagement. They also discussed the various engagement tools available to passive investors and considered their merits and demerits. Divestment, in particular, was discussed as a unique challenge for passive investors.”
Based on these observations, the PRI offered a range of recommendations. To asset owners, the organisation emphasised the need to continue to strive to improve disclosures and reporting by asset managers, as well as keeping an open mind about changing benchmark or index selection.
The PRI suggests asset managers and service providers adopt more collaborative approaches to engagement. For the organisation, the development of public approaches to systemic issues such as climate change and governance is also crucial. Asset managers should also construct and market new financial products transparently and consistently while promoting better corporate ESG data. Finally, asset managers should ensure the quality of ESG rankings and scores is based on transparent and consistent processes, and that clear explanations accompany any changes to indexes or benchmarks.
Lastly, the focus of regulators should be to encourage clear and consistent reporting and review “acting-in-concert” guidelines to ensure these do not prevent collaborative engagement