"It is very difficult to win any money now unless you have a strong ESG story." So how are firms managing their ESG investment approach? We spoke to Aviva Investors about theirs.

Since the launch of the UN Principles for Responsible Investment in 2006, the number of signatories has grown to over 3,000. Total assets managed under the principles have risen from $20 trillion a decade ago to just over a $100 trillion today.

That is lot of capital under scrutiny as investors increase demand for ESG-qualified funds.

But what is an ESG-branded fund? And how are companies flexing their ESG expertise in practical ways to show investors the way?

From a midsize asset management perspective, this service spoke to Mirza Baig, global head of ESG corporate research and stewardship at Aviva Investors.

As a member of the leadership team, reporting directly to Aviva's chief investment officers in equity, credit, and multi-asset, Baig says the firm has done “a huge amount of work” looking at what data points it reports from an ESG perspective for the portfolios.

“Our CEO Euan Munro owns our overall ESG strategy and that is delegated to an executive committee, which consists of each of the CIOs."

In terms of ESG resources, the team “has hovered” around seven or eight people over the past decade but is now closer to 30, he said. The firm has built up the most capacity in liquid markets research, with seven dedicated ESG analysts, a macro analyst, and is adding thematic analysts.

One big change has been embedding teams into the respective asset classes and moving away from a "siloed" management structure. Another has been the involvement of the CIOs, who spend around 20 per cent of their time on ESG.

A legitimate criticism of ESG has been the meaningfulness of the data, from uneven biases given out by ratings agencies to the bottomless resources large caps employ to cast themselves in a positive light.

“There are those companies that have a lot of money to throw at gaming the data, and it is up to analysts to see through that," Baig said.

Their day-to-day job "is looking at the data, engaging with companies, and looking at a broader set of data points as well and forming a qualitative view on whether a company is positive or negative. And it can cut both ways," he said. “Some companies score very poorly on standardised metrics and they don’t actually capture the positive transition the company has made.”

The firm ranks companies on a zero to 10 quant-based ESG score and provides qualitative research notes that are rated positive, negative or neutral. It is those time-consuming qualitiative assessments that “carry more weight.”

 “If I were to say where the substantive cost base is, it is in that qualitative expertise,” Baig said.

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As the market for sustainable investing continues to heat up, Aviva and others have to convince investors bombarded by ESG-branded products that their approaches are more than collecting data and generating research and insights.

“If that research isn’t actually impacting on how we manage our money, then who cares to some extent? It’s just words,” Baig said.  

The firm has identified three factors that are collectively changing team behaviour. The first is a conviction that ESG improves investment performance. The second is client interest - "It is very difficult to win any money now unless you have a strong ESG story" - and the third is regulation.

That third lever has just shifted up a gear with the arrival of the European Sustainable Finance Disclosure (SFDR) regulation. Introduced last month, it requires asset managers to label which investment products are sustainable and which are not. Managers failing to label funds accurately risk having them downgraded.

SFDR is the first serious piece of rule-making to test how serious asset managers are about sustainability. The centerpiece of the EU’s green finance initiative, the goal is directing meaningful capital, and lots of it, towards meeting aggressive carbon reduction targets that up to now have been little more than marketing pledges.

Under the rules, EU funds will fall into three categories. Article 6 covers funds that may integrate ESG but don’t have ESG objectives connected to them. Article 8 covers ESG-promoting funds, where ESG is part of the investment philosophy but impact is not measured. The most stringent Article 9 is where managers list dedicated ESG-impact funds.

Anyone globally marketing a fund to European investors will have to comply with the new classifications that will also put pressure on listed companies to pay heed to the shade of green funds are labelled when competing for capital.

“Over the long term, if you look at SFDR and how they are defining Article 8 and Article 9 funds, it will simplify the process,” Baig said.

Last week, Morningstar released the first data outlining how asset managers should catalogue funds under the new regime.

The analyst estimates that the total value of Europe’s ESG/sustainable funds market is worth €2.5 trillion based on the re-labelling, with 25 per cent of funds being logged under Article 8 and Article 9.

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There is plenty more action to come.

“Managers have plans to enhance existing strategies, reclassify funds, and launch new ones that will meet at least Article 8 requirements,” Hortense Bioy, global director of sustainability research at Morningstar, said.

Different managers are taking different interpretive approaches, with some being more conservative for fear of having to downgrade funds later.

“It is clear from the asset managers we spoke to that it is essential for them to have as many funds as possible classified as Article 8 or 9. They see compliance with at least Article 8 requirements as an opportunity to demonstrate their commitment to sustainable investing,” Bioy said.

A second phase of disclosure landing next year requires asset managers to report on other aspects, such as the carbon footprint of their allocations, and their exposure to fossil fuels and other controversial sectors.

Equally important for Baig at Aviva Investors is making sure that advisors understand ESG. The firm, which manages around $365 billion, has run a series of three-week training programmes on the investment principles, covering terminology, regulation, and other emerging issues.

“ESG is quite nebulous. It means all things to all people and in some cases nothing at all," Baig said. "The problem has always been can advisors A understand their clients needs, and B map it to our funds. Of all the sessions Aviva has done, ESG, by multiples, is the highest numbers of attendees we have had,” he said. Over a thousand advisors signed up for the programme.

As a foundation for ESG integration, Aviva commissioned a team of data scientists to filter hundreds of data points across 21 different industries to identify the most material ESG data points associated with a company's future performance. It took 18 months, Baig said. From there, it built a proprietary ESG tool that assesses around 20,000 securities, with 300 or so core stocks within that targeted for additional analysis.

In respect of what clients are asking advisors about ESG, on the more progressive end “they want to understand impact rather than process, and that is in every single sphere of ESG.”

“If you are integrating, what does it actually mean for your portfolio? Don’t just tell me you have a research function,” he said.  

Also resonating with clients is the portfolio review process. “For all of our key strategies, we will have a quarterly session where we review portfolios and identify ESG concerns, have a debate and then expect the portfolio to change as a result of that process,” he said.  

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“For example, we are sellers of Bayer and buyers of Merc and that is almost exclusively a result of our ESG views on those stocks.” Aviva described its tussles with the German pharmaceuticals giant in its annual sustainability report published yesterday.

Besides a European and a global version of the Aviva Climate Transition fund, Baig said the firm expects to launch a series of SDG-linked impact funds over the next 12 months to broaden investor options. The investment firm is owned by insurance giant Aviva PLC, its largest client.

In March, it launched OEIC feeder versions of the Aviva Stewardship Funds to bring the range to the UK wholesale market. The four funds, launched back in 1984 and managed by Aviva since 2018, account for around £2.5 billion in assets managed.

Beyond these specialist vehicles, “every single strategy, both liquid and illiquid, has ESG built into the research and portfolio construction process. And it is audit-quality ready,” Baig said.

Clients are also moving beyond climate change as their primary investment interest, which the firm sees as positive. The 17 SDGs are raised in every client meeting now, Baig said. “It might not always translate into an appetite for a particular fund but they want to know how the SDGs are affecting their core strategies and what we are doing on the engagement side. [However,] we don’t want to go too niche into a singular theme because to get a reasonable level of client engagement, it needs to tick various boxes.”

Whether greater client engagement is driven more by risk and the prospect of stranded assets or more by conviction and belief is something the firm is still grappling with, Baig says, and it depends on which market the client is from.

"It won’t come as any real surprise that the Nordics and the Dutch are probably more leaning towards the social impact side rather than the return side of it, and that they have an obligation to leave the world in a better place. For some pension funds that is a twin objective written into the foundations of the fund."

"In principle, we don’t really see a contradiction between the two and that’s how we’re approaching things. If you look over a longer term horizon, if you are talking six months, the whole thing falls down. But if you talk three, five, 10 years, we believe companies will only really succeed if they do make a positive impact with the stakeholders they are interacting with. In which case, it is a win-win.”