ESG Investments | Finding your way and avoiding pitfalls

Published on April 23, 2023

By: iA Global Asset Management's team of investment specialists

More and more Canadian investors expect to have access to one form or another of ESG investment solutions. As a result, careful consideration is required to integrate the right environmental, social and governance (ESG) solution into group retirement savings plan sponsor offerings.

Setting sustainable investment objectives, tracking progress and reporting on how these objectives are met is not a straightforward exercise. Why? Because there are no industry-wide standards on ESG products. Not only do people have varying expectations of sustainable investing products, it can take years to achieve the sustainability objectives set by the investment manager.

These challenges make it difficult for them to determine how ESG-conscious (according to their own interpretation and definitions) an investment actually is, opening the door to investment products giving the impression that they are, in fact, what they are not.

Hence the greenwashing problems.

Problematic labelling

It’s easy to miss the mark if there is no set way to determine what the mark is, especially when the indicators to track progress and the methods of reporting are not clearly defined.

For example, without accurate climate change metric disclosures, it becomes increasingly difficult to assess the material risks that climate transition poses to an investment solution, which makes it hard to make informed investment choices. A number of market reports published in the last few years in Canada describe the same general problem: ESG data in Canada—and abroad, for that matter—is often poor quality, hindering direct comparison of ESG objectives and implementation between specific investments.

But that’s not the end of it. Regulatory expectations continue to evolve, making it challenging to know if ESG investing is simply a box-ticking exercise. It’s a process that many see as more of an art than a science. Not to mention that complying with principle-based regulatory standards, which allows for a wide array of interpretations, has never been easy.

Regulatory bodies across multiple jurisdictions in both Europe and North America are aggressively tackling this problem, but compliance standards still vary widely.

As institutional investors start using ESG factors as a tool for both risk mitigation and value enhancement, plan sponsors looking at ESG investments need a list of criteria they can use to assess products against their own needs and expectations.

Due diligence on disclosure

Disclosure by public companies is on the rise across the board, but both investors and plan sponsors must have the right tools to be able to offer solutions that match their plan members’ and employees’ core values and priorities. This alignment is becoming an important fiduciary issue for retirement savings programs in Canada.

The lack of consistent data collection for greenhouse-gas emission metrics, for example, is an obstacle to properly assessing companies’ progress, especially when many have pledged to reach net zero greenhouse gas emissions. That is why there needs to be more discussion around how entities are responding to the risks and opportunities posed by environmental, social and governance issues. Ultimately, plan sponsors must ask how their asset managers are dealing with these considerations.

To identify real ESG investments, plan sponsors require scorecards and benchmarks that will help them determine if the proposed objectives are right for them. Whether the aim is to reduce material risk, align pension investments with the organization's overall philosophies or address a moral imperative, no plan sponsor wants to dive in and then find out that the products’ asset management practices are not on par with what they—and their plan members—had thought.

For those with limited experience or resources, seeking expert assistance may be a helpful way to navigate the complexities of ESG investing. This could involve working with an asset manager who specializes in ESG strategies or consulting with a third-party expert who can provide guidance on selecting ESG-friendly investments.

Probing deeper

Plan sponsors should evaluate the service providers' environmental credentials before investing. Digging deeper than the byline and looking to identify the person or team at the firm whose responsibility it is to act on those policies should also be on the radar.

For instance, before investing, plan sponsors should ask how an asset manager integrates environmental, social and governance risks into their security selection process. A good measure of that integration could be found in the asset manager's proxy voting policy and the records of votes they've made in the past. If a manager is serious about implementing environmental strategies, it will show up in their investment stewardship practices, and this applies whether the investment manager is active or passive in their investment approach.

Determining whether greenwashing is taking place also means looking at how asset managers make their investment decisions and what tools they are using. Assessing the whole picture before investing is the key. Managers may check the overall ESG performance of the securities in which they invest, but they may give more weight to certain criteria, to the detriment of others. A security could make it into a portfolio because it scores well on specific metrics despite poor scores on others.

By keeping these challenges in mind, plan sponsors can more effectively navigate the complex landscape of ESG investing and avoid the pitfalls of greenwashing.