ESG, diverse manager selection evolves to meet historic institutional investor interest

As both ESG and responsible, emerging and diverse manager investing comes to the foreground for general and limited partners alike, Aon’s dynamic head of ESG, Meredith Jones, frames the conversation in a very incisive way.

Joining Aon in 2015, Jones is a partner spearheading the consulting firm’s ESG practice in addition to leading research on emerging managers, MWBE managers and responsible investing.

Her investment career began at fund of hedge funds Van Hedge Fund Advisors International, where she was director of research. She then joined hedge fund analytics provider PerTrac Financial Solutions.

The research on emerging managers and women and minority-owned funds has changed the way investors and money managers behave — both in the way investors allocate and how money managers market to and seek investors.

Jones has brought her hedge fund industry experience to Aon, and created a process propelling both managers and investors forward toward products that are both good for the planet and their portfolios.

Vailakis: Thank you Meredith for agreeing to share your insights with the Alternatives Watch community.

Please talk me through the evolution of ESG for asset managers since the beginning of your tenure at Aon.

Jones: Thank you for agreeing to chat about one of my favorite topics, Nancy.

Trump’s election in 2016 marked a considerable upward trend in ESG interest from limited partners (LPs). Assumptions that regulation would govern corporate behavior around pollution, climate change, diversity and inclusion, social justice, etc. gave way to an understanding that the administration’s anti-regulatory stance required investors to drive demand around environmental, social and governance concerns. The four months post-election saw a marked uptick in allocations to sustainable investments, as well as increased interest in assessing environmental, social and governance related questions.

And this was not the first time investors reacted this way to regulation (or lack thereof). A similar dynamic played out when the Paris Agreement was signed — there were net outflows from ESG focused/responsible investments because investors believed global regulations would help drive positive change. And of course, when the U.S. announced its intention to pull out of the Paris Agreement in 2017, there were inflows to ESG-focused/responsible investments as allocators looked to their investment dollars as the major potential change agent.

Now in 2020, the double whammy of COVID-19 and protests around social justice has spiked interest in ESG generally, with a particularly heavy focus on the social component. Until this year, the “S” in ESG was often the red-headed stepchild of the ESG world, but now issues around human capital management, workforce safety, stakeholder (not just shareholder) value, diversity and inclusion and community engagement have been elevated. We are seeing increased investor focus and lots of thought leadership and policy changes from investment management firms to address these concerns. At the same time, the comparative outperformance of ESG-themed or “sustainable” funds amidst market volatility in 2020 has driven even more investor interest. As a result, we see product development and corporate action around ESG accelerating like never before.

Vailakis: Diversity is a part of the ‘S’ or ‘social considerations’ that make up ESG assessments. What is shifting on this topic at the moment?

Jones: I have been involved in diversity efforts for more than a decade now, and during that time there has been a lot of talk about diversity and inclusion, and large investors in 26 states have allocated funds to diverse asset managers, but we haven’t seen real systemic change. In fact, the 2019 Knight Foundation/Bella Research Study found that as of 2018, diverse asset managers were still only managing 1.3% of total industry assets under management.

The recent protests about the lack of social justice have illuminated the need for real, systemic change, and we are already seeing evidence that the investment industry would like to be part of that change. Where the industry has historically been more focused on signaling their intended commitment to diversity, equity and inclusion, now we’re seeing demands for evidence of those efforts. It will no longer be sufficient to talk about policies and outreach and programs. I believe that firms will now be expected to talk about hiring, retention and promotion rates, and will be expected to show evidence and progress in each of those areas.

Vailakis: Please draw a distinction between ESG and responsible or social impact investing.

Jones: ESG initiatives are all about identifying and mitigating environmental, social and governance risks before they become financial problems. It isn’t as much about appearing “nice” or about making gestures that aren’t impactful to the bottom line, although certainly being a good corporate citizen is always welcome.

But while the goal of ESG policies and initiatives is not necessarily to make the world a better place, theoretically the outcome of all firms focusing on these risks would create a more resilient global economy, environment and workforce.

Responsible or social impact investing takes a values-oriented approach where the first focus isn’t generally on risk management. Instead, investors focus on what they want to see more of (or less of) in the world and invest in a way that either encourages those outcomes or avoids those industries altogether.

In impact investing, you generally look at what you want to see more of, such as more access to healthcare, more renewable energy, more diversity and inclusion. However, there are also investors who simply screen out of their portfolios the things they don’t believe have a place in global society. For example, there are investors who avoid fossil fuels, tobacco, firearms, adult entertainment or gambling. It’s important to remember though that these are value-based judgements and may or may not have fiduciary repercussions under ERISA guidelines. As a result of these regulations, investors need to carefully evaluate any values-based investment before proceeding.

Vailakis: Please speak to ESG policies that simply angle toward avoiding bad actors.

Jones: Divestment is always an option if there is no way for a company to change its behavior. However, we do encourage investors to consider staying invested and increasing engagement if there is a chance a company could evolve. In this way, investors can be a positive force for the change they wish to see. For example, if one simply divests wholesale from fossil fuel companies, the remaining investors (of which there are still plenty) may not encourage reductions in emissions, carbon capture techniques, transitions to renewable energy sources, etc. For companies that are unwilling or unable to change their ways, however, such efforts at engagement may not be fruitful or a good use of time, and then targeted divestment becomes a real option.

Vailakis: Any closing thoughts?

Jones: Given demographic changes, rapidly evolving public sentiment on a host of ESG issues, the global regulatory environment and market volatility, I expect that we will continue to see ESG and responsible investment activity accelerate across the investing value chain.

Whether we’re talking about corporate issuers assessing and disclosing their ESG risk, investment managers launching ESG and responsible investment products, investors calling for additional ESG integration or tracking diversity efforts across their portfolio, it seems that we are at a critical inflection point. Forward momentum is increasing with each passing day. If you had asked me a year ago whether ESG/RI would have made as many strides within the investment community, I would have said “absolutely not”. But the events of the last six months have brought about unprecedented challenges, and increased attention on ESG, resiliency and diversity and inclusion are the bright side.