State Street Global Advisors is the investment management arm of State Street Corporation. ESG investing is central to its mission of investing responsibly to enable economic prosperity and social progress. RIAA hears from Rakhi Kumar, Head of ESG Investments and Asset Stewardship around State Street’s responsible investment work.
Under the Bonnet – State Street Global Advisors
1) With ESG integration largely recognised as foundational to good investment management, how are you measuring and reporting on ESG performance as well as other responsible investment activity including corporate engagement?
Investors around the world increasingly evaluate a company’s ESG performance with the same level of rigor that they would look at any traditional financial measure. In addition, beneficiaries and stakeholders are demanding greater insight into the ESG profile of their investments. These factors are leading to greater interest in robust reporting along dimensions such as carbon intensity and controversy exposure, as well as more comprehensive, transparent tools for evaluating a company’s overall ESG profile.
At State Street, we are committed to using our resources and influence to strengthen ESG investing around the world. We are doing this in three primary ways: scoring (data), solutions and stewardship.
We recognise that the lack of transparency and consistency among ESG data providers is one of the biggest challenges facing investors today. To address this, we have built our own multi-source data architecture that aligns with the transparent sustainability materiality framework developed by the Sustainability Accounting Standards Board (SASB) and incorporates governance-related insights from our stewardship efforts. We believe that providing transparency about our methodology is essential to helping investors make sound decisions that align with their values and enabling corporate boards and management teams to strengthen their sustainability practices.
This data informs the broad array of ESG-related investment solutions that we offer. These range from exclusionary screening to climate-themed strategies across investment styles and asset classes. In addition to these solutions, we also offer fund- and portfolio-level ESG reporting for clients.
A robust stewardship program underpins our entire approach to ESG investing. We identify thematic and company-specific issues related to sustainability that are important to our clients. We then use our influence—both in terms of voting and engaging with boards and management teams—to effect change with our portfolio companies and mitigate the ESG-related risk in our portfolios. Our approach to asset stewardship involves tracking the progress of companies we have engaged with, publicly reporting on our engagement and voting activities on a quarterly and annual basis, and publishing thought leadership to inform our portfolio companies and enhance the understanding of other market participants.
2) What changes are you seeing in how investors source ESG data?
Historically, investors have been reliant on a single source of ESG data to inform their investment processes. This data typically comes from third-party providers that offer little transparency into their scoring methodology and materiality framework. As a result, using data from a single provider means that you’re essentially subscribing to that provider’s investment philosophy and views on materiality—without knowing whether those views align with your own.
In addition to these transparency concerns, recent State Street research shows that there often is low correlation between how different data providers score the same universe of companies.[1]This highlights the lack of consistency and uniformity among ESG data sources.
To address these challenges, more investors—and their consultants—are embracing investment solutions and strategies that are based on ESG data from multiple providers. As more investors become aware of the limitations of ESG data, we expect this multi-provider approach to become increasingly common across the industry.
[1]Bender, Bridges, et al. A Blueprint for Integrating ESG into Equity Portfolios. Journal of Investment Management. Vol 16, No 1, 2018.
3) Corporate engagement is a significant part of State Street’s work. How are you responding to the notable increase in ESG resolutions?
We hold more than 12,000 listed equities across our global portfolios. As a result, the success of our engagement strategy depends on our ability to focus on companies and issues that potentially will have the greatest impact on shareholder returns. Each year we identify several thematic ESG priorities to guide our stewardship activities for the year. This allows us to focus our engagement efforts on the sector-specific or thematic ESG issues that will have the greatest impact on our clients.
In addition to thematic ESG priorities, we also identify two or three ‘deep dive’ sectors each year for our engagement efforts. This allows us to spend an entire year proactively monitoring and engaging with companies in those sectors on matters such as long-term strategy, performance and ESG issues. Reviewing our global holdings in a sector gives us the ability to identify business and ESG trends impacting our holdings. This strengthens our ability to provide input to boards and management when they seek feedback or direction from large institutional investors. We share these sector-specific insights with clients through presentations and our Annual Stewardship Report.
4) Being a large passive manager, you’re not able to divest. What happens when corporate engagement fails?
As one of the largest index fund providers in the world, a huge portion of the assets we manage are essentially permanent capital. Unlike in our active strategies, our index fund managers can’t walk away from a company that is in the index. This is why it’s so important for us to develop partnerships with our portfolio companies. Our long-term ownership, together with our size and global reach, informs our perspective and enhances our influence with portfolio companies.
Our Fearless Girl campaign is an example of how we are using this influence. Since March 2017, we’ve called on more than 1,200 companies with no women on their boards of directors to take action. In addition to engaging directly with these companies, we have used our voting power to encourage these companies to take action. For companies that hadn’t taken adequate steps to address their lack of diversity, we voted against the chair of the nominating committee; we did this for more than 500 companies in 2017 and more than 500 companies in 2018. We are pleased that, as of June 2018, more than 300 companies added a female board member, including 21 Australian companies.
Going forward, we are ratcheting up these efforts by expanding our voting guidelines. We will vote against the entire slate of board members on the nominating committee if a company is unresponsive to our engagement efforts for three consecutive years.
5) What ESG issues are showing greatest prominence and are areas you are researching?
As extreme weather events become more frequent and the economic impact of climate change becomes more widely understood and accepted, investors will require companies to disclose how they are adapting their business strategies to mitigate the risk posed by environmental factors.[1]This is especially true now that regulators and companies have started to act on the recommendations of the Financial Stability Board’s Task Force on Climate-related Financial Disclosures (TCFD). Starting with the agriculture and forestry industry, we are researching how companies in various sectors can align their reporting practices with the TCFD’s proposed framework. Similarly, we are researching how clients can align their portfolios with the United Nations’ Sustainability Development Goals.
Another area that we believe has shown significant progress is the broadening of climate-related investment solutions. In the past, investors’ options were generally limited to a) screening out companies that are heavily dependent on carbon emissions or avoiding industries with significant climate-related risk exposure or b) mitigating climate risk by reducing the portfolio’s exposure to carbon intensity, fossil fuel assets and “brown” revenue derived from extraction or power generation from fossil fuels, as well as increasing exposure to companies that generate ‘green’ revenue from low-carbon opportunities.
[1]Intergovernmental Panel on Climate Change: Global Warming of 1.5oC; Fourth National Climate Assessment Volume II: Impacts, Risks, Adaptation in the United States
5) What ESG issues are showing greatest prominence and are areas you are researching?
As extreme weather events become more frequent and the economic impact of climate change becomes more widely understood and accepted, investors will require companies to disclose how they are adapting their business strategies to mitigate the risk posed by environmental factors.[1]This is especially true now that regulators and companies have started to act on the recommendations of the Financial Stability Board’s Task Force on Climate-related Financial Disclosures (TCFD). Starting with the agriculture and forestry industry, we are researching how companies in various sectors can align their reporting practices with the TCFD’s proposed framework. Similarly, we are researching how clients can align their portfolios with the United Nations’ Sustainability Development Goals.
Another area that we believe has shown significant progress is the broadening of climate-related investment solutions. In the past, investors’ options were generally limited to a) screening out companies that are heavily dependent on carbon emissions or avoiding industries with significant climate-related risk exposure or b) mitigating climate risk by reducing the portfolio’s exposure to carbon intensity, fossil fuel assets and “brown” revenue derived from extraction or power generation from fossil fuels, as well as increasing exposure to companies that generate ‘green’ revenue from low-carbon opportunities.
But recently investors have begun using an approach that we call ‘mitigation and adaption’. In addition to reducing exposure to worse-than-average carbon emitters and ‘brown’ revenue and increasing exposure to ‘green’ revenue, this approach involves tilting the portfolio toward more environmentally resilient companies and ones that are adapting their long-term strategies to account for their exposure to climate risk.
[1]Intergovernmental Panel on Climate Change: Global Warming of 1.5oC; Fourth National Climate Assessment Volume II: Impacts, Risks, Adaptation in the United States
6) As one of the world’s largest asset managers, what regulatory and policy developments are you seeing that are influencing the supply and demand for responsible investments?
After years of deliberation about how the financial services industry should address climate change and other ESG issues, there was major progress on multiple fronts in 2018 to convert these principles into legislative and regulatory frameworks. In addition to growing support for the TCFD’s recommendations, countries around the world have begun to codify their commitments to the 2015 Paris Agreement on climate change. Not surprisingly, Europe is leading the charge in this area, mandating that investors consider ESG information in their investment process.[1]
These developments have put tremendous pressure on investors to keep up with evolving regulatory initiatives. In addition to simply complying with regulatory requirements, many investors are expanding their investment objectives in response to a growing awareness of the direct effect that ESG factors have on a company’s long-term financial performance. This is especially true for climate change, as many companies are establishing targets for emissions reduction, water efficiency and other environmental sustainability goals.
Whether driven by regulation, a belief in the long-term financial impact of sustainability or a desire to align a portfolio with the investor’s values, there is clearly growing demand for responsible investing. At State Street, we approach every aspect of ESG investing—from gathering data to designing solutions and engaging with companies—from the perspective of a fiduciary that is focused on generating sustainable returns over the long term for our clients.
[1]“EU Pushes for benchmarks with 2oC scenario analysis.”Responsible Investor, December 14, 2018.