How ESG has become the way to better risk-adjusted returns

Envi­ron­men­tal, social and gov­er­nance (ESG) con­sid­er­a­tions have shot up the pri­or­i­ty order for com­pa­nies and investors alike in recent years. Once per­ceived as a box-tick­ing exer­cise, or even win­dow-dress­ing, ESG is now approached for what it is: a core risk and oppor­tu­ni­ty, impact­ing busi­ness­es and the long-term returns of investors and pen­sion scheme mem­bers.

High-pro­file cam­paigns such as ‘Black Lives Mat­ter’, ‘Make My Mon­ey Mat­ter’ and those by Sir David Atten­bor­ough have ele­vat­ed the pub­lic con­scious­ness around social and envi­ron­men­tal issues, and con­sumers increas­ing­ly expect the brands they inter­act with to align with their own per­son­al val­ues. This real­i­sa­tion has con­tributed to a grow­ing recog­ni­tion that com­pa­nies that pay more atten­tion to ESG and embed it in their core busi­ness goals are more suc­cess­ful and less risky to invest in.

This height­ened pub­lic aware­ness around ESG issues and cam­paigns has fil­tered firm­ly through to the investor agen­da. Even if com­pa­ny lead­er­ship teams don’t recog­nise the impor­tance of ESG, increas­ing engage­ment on the sub­ject by asset man­agers and asset own­ers is forc­ing them to take it more seri­ous­ly. Mean­while, reg­u­la­to­ry pres­sure, espe­cial­ly in the area of envi­ron­men­tal sus­tain­abil­i­ty, is mak­ing ESG a con­cept that busi­ness­es can’t ignore.

“ESG was pre­vi­ous­ly not viewed as crit­i­cal – it was a nice to have,” says Adri­an Mitchell, chief invest­ment offi­cer of Aon’s fidu­cia­ry man­age­ment busi­ness in Europe. “But it is now inte­grat­ed in all invest­ment deci­sions, cer­tain­ly for the man­agers in which we invest. Invest­ment strate­gies have evolved from pure­ly look­ing at the ‘G’ of ESG — how com­pa­nies are run, which has a big impact on the finan­cials — to look­ing much more at the social and envi­ron­men­tal fac­tors as well. We’re also start­ing the grad­ual move towards ful­ly sus­tain­able prod­ucts and we expect to see that accel­er­ate due to net-zero com­mit­ments and reg­u­la­to­ry pres­sure.

“First and fore­most, we are still focused on hit­ting the right finan­cial returns for our clients, but we have also ful­ly inte­grat­ed ESG into our process­es and make sure we man­age those risks asso­ci­at­ed with the tran­si­tion to a low-car­bon world. There is now a grow­ing inter­est and accep­tance that as long as we can con­tin­ue to hit the invest­ment objec­tives that clients set, then it is also very impor­tant to build some non-finan­cial goals, par­tic­u­lar­ly around ESG, into invest­ment port­fo­lios.”

Aon’s UK fidu­cia­ry busi­ness is a huge aggre­ga­tor of pen­sion scheme assets, work­ing for more than 100 clients with a total in excess of £23bn of assets under management1. This scale gives Aon more oppor­tu­ni­ty than a typ­i­cal pen­sion scheme to engage on ESG issues with the under­ly­ing asset man­agers and, in turn, ensure they are engag­ing direct­ly with com­pa­nies to dri­ve change.

Aon’s holis­tic approach to build­ing port­fo­lios focus­es on inte­gra­tion, incor­po­rat­ing mate­r­i­al ESG risk fac­tors into invest­ment analy­sis and deci­sion-mak­ing through its asset allo­ca­tion and report­ing tools, and invest­ment man­ag­er rat­ing process. Aon’s engage­ment with the under­ly­ing asset man­agers seeks to ensure that their ESG plans align with Aon’s and it mon­i­tors met­rics, par­tic­u­lar­ly around cli­mate, to be proac­tive in devel­op­ing ESG solu­tions and funds.

In Sep­tem­ber 2020, Aon launched the Glob­al Impact Fund, its first fund with non-finan­cial sus­tain­able devel­op­ment goals as well as the objec­tive of out­per­form­ing the MSCI World Index. The fund, which invests in equi­ties across the world, is up by more than 20% since its launch and has been an impor­tant demon­stra­tion for the mar­ket that funds can have non-finan­cial goals with­out hav­ing to sac­ri­fice finan­cial per­for­mance.

Com­mu­ni­ca­tion and edu­ca­tion are also cen­tral to Aon’s ESG strat­e­gy. On the defined ben­e­fit pen­sions side, Aon runs a series of webi­na­rs, road­shows and trustee train­ing on the impor­tance of ESG in client port­fo­lios. On the defined con­tri­bu­tion (DC) pen­sions side, in which scheme mem­bers are typ­i­cal­ly younger, the com­pa­ny has noticed a will­ing­ness from clients to engage on ESG, which is par­tic­u­lar­ly impor­tant giv­en mem­bers will be con­tribut­ing to their pen­sions over mul­ti­ple decades.

“Pro­vid­ing trans­paren­cy around how mem­bers’ sav­ings are invest­ed is impor­tant, as well as being upfront about some of the risks,” says Jo Sharples, chief invest­ment offi­cer for Aon’s DC solu­tions. “Envi­ron­men­tal risk in par­tic­u­lar does make a big dif­fer­ence to their invest­ments, so we share infor­ma­tion with mem­bers and show the steps we’re tak­ing. The will­ing­ness to engage from DC mem­bers is part­ly because they can relate to the things they see in the media and online, but more impor­tant­ly the returns we gen­er­ate direct­ly impact on what their retire­ment will be like.

“For DC pen­sions, a lot of the pen­sion schemes have a young age pro­file. For some­one enter­ing the work­force now, aged 21, they are look­ing at pos­si­bly a 60-year invest­ment time­frame, so these issues become real­ly per­ti­nent. Younger mem­bers, who are also more like­ly to be social­ly aware, want to know their mon­ey is invest­ed in the right way. We often hear that peo­ple aren’t engaged with their pen­sion, but if you show what their mon­ey is doing to dri­ve social and envi­ron­men­tal impact, they’ll engage more and per­haps even put more in. We’ll see more tools become avail­able to help mem­bers under­stand in which com­pa­nies their pen­sion is invest­ed and what is being done to man­age some of these risks.”

Green­wash­ing, where com­pa­nies make ESG claims they don’t ful­fil, can be a chal­lenge, but Aon works dili­gent­ly to ensure it only invests in under­ly­ing asset man­agers that are ‘buy’ rat­ed by its man­ag­er research teams. And once a com­pa­ny is buy rat­ed, Aon con­tin­ues to mea­sure, through active engage­ment, whether the organisation’s actions are match­ing its com­mit­ments.

ESG will undoubt­ed­ly con­tin­ue to shape the invest­ment and asset man­age­ment land­scape in the years ahead, and Aon is ded­i­cat­ed to fur­ther build­ing on its mar­ket-lead­ing posi­tion in this area. That is like­ly to include evolv­ing from its cur­rent focus on full inte­gra­tion toward a much more car­bon neu­tral and sus­tain­able port­fo­lio, includ­ing impact strate­gies with non-finan­cial goals.

“We’ll see the focus on ESG spread from equi­ties to non-equi­ty asset class­es such as bonds,” says Mitchell. “Reflect­ing this, we will soon be launch­ing a Sus­tain­able Mul­ti Asset Cred­it Fund. Addi­tion­al­ly, as an aggre­ga­tor of pen­sion scheme assets with stew­ard­ship respon­si­bil­i­ty, Aon is in a bet­ter posi­tion than oth­er asset own­ers to influ­ence how the under­ly­ing asset man­agers inte­grate ESG into their process­es and will con­tin­ue to exer­cise our respon­si­bil­i­ties in this area.”

For more infor­ma­tion please vis­it aon.com/responsibleinvestment

Pro­mot­ed by Aon