In September, 12 asset allocators and managers announced that they had signed on to a new stewardship code that committed them to transitioning their investment portfolios to net-zero greenhouse gas emissions by 2050. Signatories included PensionDanmark, Caisse de dépôt et placement du Québec, and Allianz, among others.
Following the announcement, the signatories were treated to coverage by Reuters, The New York Times, the Financial Times, CNBC, and a number of local news sources. Such is the case whenever a group of asset allocators and managers signs on to a new code promising that they’ll engage in more responsible investing.
And they sign on often. There are more than 20 stewardship codes, or contracts signed by investors, that encourage responsible investing worldwide. As investors scramble to engage with the latest code, it is becoming clear that the codes don’t actually change how they make investment decisions.
Here’s why: These codes rarely include requirements for how allocators or managers should change. Instead, they are almost always vague, enabling many to sign on and then interpret the requirements in a manner that best suits their needs. Signing on to a code garners good press while imposing little to no restrictions on allocators or managers. What could possibly be the downside?
Take, for instance, the 13 institutional investors that signed on to a framework called Principles for a Responsible Civilian Firearms Industry back in 2018. This code, which encourages gun manufacturers and firearms distributors to adopt best practices via shareholder engagement, was met with media coverage from Institutional Investor, Bloomberg, and Pensions & Investments, among other sources. It is too soon to judge the efficacy of this particular code, but that, in a sense, doesn’t matter. Investors still got great press in exchange for a simple signature.
And research shows the good press is a primary driver for some institutions to sign on to these codes. In a May survey by Natixis Investment Managers, 70 percent of nearly 500 institutional investors said that “improved image and reputation” was the primary benefit of incorporating environmental, social, and governance (ESG) strategies into their portfolio.
Yet according to Michael McCauley, senior officer of investment programs and governance at the Florida State Board of Administration, signing on to the firearms code was about more than the good press. “It was post-Parkland, and it made sense for us to pursue that,” he said by phone. McCauley added that codes like the firearms one “allow us to punch a little above our weight. There’s strength in numbers.”
The code, however, did not include clear provisions on how its success would be measured. This, it appears, is a pattern among stewardship codes.
Like the firearms code, the net-zero-emissions code is not specific in how signatories enact it. According to the code, investors will be required to set portfolio targets for 2025, 2030, and 2040 that demonstrate progress toward their long-term goal. But the alliance’s frequently asked questions brochure shows that asset owners are not required to divest from their “emissions-intensive assets.” Instead, the measures focus on advocacy and engagement to encourage portfolio companies to change the way they do business to get to net-zero emissions by 2050.
“While an asset owner retains full discretion as to which assets it holds, the commitment requires the asset owner to take measures which bring about portfolio decarbonization and ultimately deliver a net-zero portfolio by 2050 in ways that will be as conducive as possible to GHG emissions reduction in the real economy,” the brochure says.
According to Mark Kramer, co-founder and managing director at consulting firm FSG, there is an innate problem with these voluntary codes: Companies, asset managers, or allocators will only sign on if they have good news to share. In a phone conversation with Institutional Investor, he pointed to banks signing on to codes that required them to disclose their carbon footprint. Those banks got good press, even as they were bilking customers with subprime loans, he said.
Let’s rewind a bit, and zero in on one of the earliest — and perhaps the most well-known — stewardship codes: The United Nations’ Principles for Responsible Investment.
In 2005, then-UN secretary-general Kofi Annan began working with institutions to develop the principles. Twenty investors from institutions in 12 countries joined a 70-person group of investment experts at the meeting, according to the PRI’s website. The PRI was launched a year later and has grown from 100 signatories to more than 2,300.
According to Anita Baldwin, head of research at Hartford Funds, the PRI was once an aspirational code to sign on to, where participants could sign on and get to implementing the ESG measures later. That is no longer the case. “They're now looking for authenticity from signatories,” Baldwin said. “They’re weeding out signatories who wanted to say they were signatories without making progress.”
Nowadays the PRI does require signatories to report data on their investments. But those requirements are at once arduous and vague.
Those that sign on must share their responsible investment policy, which must cover more than 50 percent of assets under management. They also must have staff responsible for implementing that policy, and have senior-level commitment and accountability mechanisms for responsible investing implementation, according to the PRI’s website. Signatories that fail to report data are delisted from the code. In 2019, ten signatories were delisted for failing to report.
Craig Metrick, managing director of institutional consulting and research at impact investing advisory firm Cornerstone Capital Group, pointed out that it can be difficult to create a meaningful stewardship code. “How do you maintain the integrity of the code and make sure it’s still meaningful and make sure there’s no free riding?” he said by phone.
For Melanie Adams, head of corporate governance and responsible investment at RBC Global Asset Management, the detailed nature of the PRI’s reporting structure is enough to ensure that investment managers are doing the right thing. “In terms of the stewardship codes and the PRI, which bring asset managers together, I would say that the reports that they require are so comprehensive and so detailed that I do think that they are effective,” she said by phone.
Adams emphasized the amount of work it takes to pull together these reports on a yearly basis, calling it an “onerous” process, but one that is worth it. She noted that RBC GAM puts in “several weeks of dedicated work” on creating the PRI report.
Yet despite all this hard work, investments made by PRI signatories appear to be falling through the cracks.
In October, shareholder advisory firm SquareWell Partners released data that showed that last year, 96 percent of the top 50 asset managers had signed on to the PRI. According to that report, which cited data from the Global Sustainable Investment Association, globally there were $30.7 trillion in sustainably managed assets. At the same time, though, the top 50 asset managers managed a combined $50.6 trillion.
In other words, the investors who had signed on to the PRI weren’t always investing in sustainable assets.
A Cerulli Associates report published in November showed that investment firms have picked up on institutions’ desire to invest with PRI signatories. While in their advertising most proclaim their ESG capabilities, their official filings tell a different story. Just 4.5 percent of PRI signatory assets are in funds that claim in regulatory filings that they factor ESG criteria into their investment decisions.
According to Cornerstone’s Metrick, the firm has come across managers who have signed on to the PRI and don’t have good ESG practices, but “we tend not to focus on those managers.”
“There are definitely managers who have signed on, and in speaking to them about how it’s really done, it may be done very well and in great detail,” Metrick said. Others, he added, may be far less thorough or attentive on these matters.
To wit: The portfolio companies of 2009 signatory KKR include Abu Dhabi National Oil Co., oil pipeline company SemCAMS Midstream, and Trans European Oil & Gas, KKR’s website shows. To be fair to KKR, the firm’s portfolio also includes renewable energy company Nitrogen Renewables, among others. A spokesperson from the firm declined to comment.
Meanwhile, TCW Group, which signed on to the code in February, includes energy corporation Chevron as a top ten holding in its relative value large cap strategy fund, its website shows. “TCW approaches stewardship questions such as UN PRI thoughtfully,” a spokesperson for the firm said via email. “As active managers, our analysts have a methodical approach to analyzing opportunities, and ESG factors are often guiding principles in assessing the value proposition offered by an issuer.”
And then there’s Vanguard. A 2014 signatory, the firm’s claim to fame is being an owner of the market itself. By default, the firm has invested in everything from oil and gas companies to private prison corporations. “Like other PRI signatories, Vanguard includes elements of ESG analysis in our investment and portfolio ownership practices as it pertains to our actively managed fixed income and equity funds,” a spokesperson for the firm said via email.
“Buying or selling securities isn’t a signal they can send to management,” said Alex Bernhardt, U.S. head of responsible investment at consulting firm Mercer. “The only way they can exercise their viewpoint is voting for or against shareholder resolutions or engaging with company management teams.” How much — or how little — a company wants to engage with management is up to them, rather than being mandated by the PRI.
These firms are certainly not alone in their investment strategies. Choose any one of the 2,698 PRI signatories and you likely will find similar inconsistencies.
“Most of these codes, particularly the UN PRI, are meaningless,” said FSG’s Kramer. “There’s no enforcement mechanism. There’s no clarity about what it means to take ESG criteria into account in investment decisions.”
For some consultants, stewardship codes are a box to be checked, rather than the end-all, be-all of ESG investing.
"I think of them as a baseline,” said Kirsten Snow Spalding, senior department director of the investor network at sustainability investing firm Ceres. “This is how we articulate our desire to be good stewards of capital.” She noted that many Ceres clients — including CalPERS, CalSTRS, University of California’s Board of Regents, the Washington State Investment Board, and the Florida State Board of Administration — have signed on to these codes but have then developed their own lists of companies they focus on and engage with.
“When I look at what’s in the [PRI], it’s so basic that our most active members would sign on without changing anything,” Spalding said. “It’s not like a stewardship code drove them to do X or Y. They were already doing these things.” As an example, Spalding noted that CalPERS has a binder that is “many hundreds” of pages long that explains how the pension fund would vote on any type of proxy provision imaginable.
The Florida SBA has a similarly granular set of corporate governance principles and guidelines that are updated yearly, according to McCauley, who calls it an “omnibus framework.” He said that the most recent revamp of the guidelines, which was three or four years ago, included the addition of guidelines on board diversity.
McCauley said that Florida SBA has signed on to and endorsed the International Corporate Governance Network’s framework, which is focused specifically on the “G” in ESG. He noted that while the SBA has tried to disclose everything required by the PRI, it hasn’t officially signed on to it because the PRI is a bit more focused on specifics than the SBA would like.
As Metrick noted, it is no longer enough for asset allocators that value ESG initiatives to ask whether investment managers are signed on to the PRI. “Almost everyone is at this point,” he said. “It’s now about asking, ‘How do you implement that?’ It’s the next level that the industry is getting to.”
According to Kramer, most investors, particularly those at firms without a strong focus on ESG, use stewardship codes to check off a box at the end of their investment process, rather than integrating them throughout.
Brad Alford, founder of search consulting firm Alpha Capital Management, said by phone that for most, returns are still more important than implementing ESG measures. “A lot of the older board members are focused on returns,” he said. “They don’t want to give it up for ESG.”
Kramer said that investment firms may have just one or two people working on ESG who are positioned to make decisions at the end of the investment process, after candidates have already been vetted for their ability to generate alpha.
“I think it would be interesting to find an example of a company that had changed its portfolio because of a stewardship code,” Kramer said. “I would be surprised if you could find one.”