The continuing evolution of investment stewardship

In today’s sustainability headlines, you can find equal parts pessimism and optimism. On the one hand, and not unsurprisingly, we see attention given to catastrophic future climate scenarios, risks of agricultural system collapse, employee and community unrest over social injustice, and a recurrence of apocalypse fatigue. On the other hand, we see news of innovative solutions in renewable investment, the advancement of mitigation and adaptation strategies, and better disclosures to increase transparency into how companies operate and how capital is governed and invested. Regardless of your vantage point on this spectrum, it’s important to recognize that we’re a long way from a world in which the biggest risks and opportunities for companies were almost universally imagined to be purely economic and where investors defined value exclusively in financial terms.

Indeed, questions of sustainability related to environmental and social factors are now intertwined with questions of financial return. Are a company’s emissions accurately reflected in its risk profile and valuation? How should an asset owner prioritize net zero alignment of its portfolio? What does an asset manager’s engagement strategy and proxy voting record say about its commitment to mitigate sustainability risks for clients? What are the outcomes attached to these activities, financial or otherwise? These are questions of stewardship, and they’re changing the paradigms of how investment success is measured and, ultimately, how markets work.

As we’ll discuss, this evolution is evident in the increasing sophistication of asset owners’ evaluations of their asset managers on sustainability and investment stewardship. Further, we see asset owner and asset manager perspectives beginning to converge more fully when it comes to nature-related risks, which are demonstrably more complex to disclose than climate-related risks. Consequently, in the long run, we see stewardship becoming central to asset owners’ criteria for determining manager selection.

"Are a company’s emissions accurately reflected in its risk profile and valuation? How should an asset owner prioritize net zero alignment of its portfolio? ... These are questions of stewardship, and they’re changing the paradigms of how investment success is measured and, ultimately, how markets work."

Asset owners want robust stewardship practices from their investment managers

Climate risks are relatively well defined, thanks to frameworks such as the Task Force on Climate-related Financial Disclosures and additional work by the International Sustainability Standards Board, and we’re getting better—across sectors—at diagnosing and disclosing climate risk exposures. Indeed, asset managers who are paying close attention to their clients’ questions know that the interest in and general sophistication around sustainability issues, particularly climate risks, have grown exponentially in recent years.

In client questionnaires in 2023, our firm received more than 1,800 questions on our sustainable investing philosophy, capabilities, and stewardship activities. Approximately 325 of these were highly involved questions requiring more than a standard response, and 13% of these, in turn, focused on climate topics. This marks a big difference from seven years ago, when a similar population of asset owners had only just begun to ask sustainability-oriented questions, the majority of which focused on our Principles for Responsible Investment (PRI) signatory status and process-related topics relative to environmental, social, and governance (ESG) integration.

We’ve seen a sizable portion of our current and prospective client base move from asking questions on the level of “Do you have a dedicated sustainability staff?” to “How many engagements did you conduct last year, how many of these were successful, and how do you judge success?” Part of this is because of the culture of transparency and accountability that good disclosure practices have fostered in recent years, but the new focus on active stewardship apparent in these questions is testimony to stewardship’s recognized significance and influence.

It should be noted that the consultant community’s activity in this space has accelerated the knowledge revolution among asset owners—and we’ve helped fuel consultants’ efforts toward being comprehensive.¹ We regularly field questions from consultants who are focused on matching asset owner needs with the right investment manager, and these questions are increasingly focused on sustainable investment and stewardship.

Regulators increasingly expect robust stewardship

Another significant alignment can be found between regulators and investors, which strengthens the voice of asset owners with their asset managers.

The Monetary Authority of Singapore’s “Guidelines on environmental risk management,” for example, articulates that asset managers should exercise “sound stewardship to help shape the corporate behavior of investee companies positively through engagement, proxy voting and sector collaboration.” This feeds directly into the execution of a sustainability strategy that includes engagement as a key pillar. In the United Kingdom, the Sustainability Disclosure Requirements hold stewardship and associated reporting as key components of any sustainable fund. Funds in the Sustainable Improvers category, for example, must demonstrate a stewardship strategy that supports delivery of a given sustainability objective and accelerates improvements in sustainability over time. Asset owners can look to these frameworks to strengthen their own expectations of their managers on active ownership.

Asset owners are taking increasingly active roles in stewardship

The alignment of regulator, asset owner, and manager perspectives is also evident in how asset owners are signing on to commitments and collaborations and are looking to asset managers to help them fulfill their obligations.

Over 730 asset owners have committed to the PRI, which means they’ve committed to the organization’s outcomes-based principles. These include a commitment to “incorporate ESG issues into investment analysis and decision-making processes,” to “be active owners and incorporate ESG issues into … ownership policies and practices,” and to “promote acceptance and implementation of the principles within the investment industry.”

Consider, as well, how Climate Action 100+ has over 290 asset owner clients who have all committed to working with companies “towards the global goal of halving GHG emissions by 2030 and delivering net zero GHG emissions by 2050, in line with the goals of the Paris Agreement to pursue efforts to limit warming to 1.5°C.” Or consider the participation of asset owners in the Taskforce on Nature-related Financial Disclosures (TNFD). Since the final version of the framework became available in September 2023, 320 companies and financial institutions, including a number of major Europe-based pension funds, have announced their commitment to start TNFD-related corporate reporting.

Navigating nature loss: the convergence of disclosure frameworks

Nature-related questions, like climate-related questions, are beginning to rise in owners’ stewardship agendas. In this, we expect to see a similar pattern of increasing sophistication among asset owners, boosted by the development of disclosure frameworks and accelerating expectations from regulators.

At the moment, there are several frameworks to help guide nature-related disclosure, and we see these continuing to sponsor more education among asset owner clients. The good news for investors who want comparable disclosures and companies that are wondering what and how they should disclose, is that these frameworks are coming into alignment. The TNFD and CDP, as well as Finance for Biodiversity, an initiative that seeks to marshal institutional commitments to action, all focus on helping institutions define their nature-related exposures and impacts, diagnose the risks and opportunities associated with those exposures and impacts, and disclose information focused on how this is being managed.

Collaborative efforts will remain significant for robust programs of stewardship, not least because they should help maintain the momentum of recent regulatory action, such as the European Union’s Deforestation Regulation. In addition to providing input into Finance for Biodiversity’s guidance for setting targets in 2023, we’re also participating in the Nature Action 100 and PRI Spring initiatives, which seek to encourage issuers to diagnose their effect on nature loss and set targets to reduce the same while promoting global policies to reverse nature loss.

The implications of investors’ rising expectations for investment stewardship

From the perspective of an asset manager, the assignment of new client mandates is now at stake in discussions of stewardship—as well it should be. Clients’ sustainability inquiries demonstrate asset owner urgency around sustainability performance. Given the patterns we’ve observed around discussions of and approaches to managing systemic risks, we expect asset owners’ sophistication on nature and biodiversity to increase and to take on greater significance for issuers, asset owners, asset managers, and regulators.

Ultimately, asset owner inquiries, client conversations, asset owner direct stewardship activities, and asset owner public statements indicate that our clients want their managers to facilitate the availability of corporate disclosure, influence the trajectory of corporate sustainability performance, and, more broadly, help determine the contours of regulatory change to address systemic risks. Stewardship, in other words, is becoming more determinative of asset owner/manager connections, and we see this as a positive for clients, the markets in which we invest, and the communities in which we operate and—for better or for worse—leave a lasting impact.