Skip to main content
PGIM Quantitative Solutions LogoPGIM Quantitative Solutions Logo
  • Learn About Us
    • Our Solutions
    • Our History
    • The Team
    • Diversity, Equity & Inclusion
    • Contact Us
  • All Insights
    • ESG
    • Market Views
    • OUTcomes Series
  • ESG Overview
    • ESG Insights
    • ESG Policy
    • Stewardship and Governance
  • Overview of Solutions
    • Quantitative Equity
    • Multi Asset
    • PGIM Wadhwani
    • PGIM DC Solutions
  • Client Log In
  • Careers
diverging rivers
Quarterly Letter

Cohesive Action Is Needed To Really Crack The ESG CodeCohesiveActionIsNeededToReallyCrackTheESGCode

By Andrew Dyson — Mar 23, 2021

10 mins

Share
  • Mail
  • LinkedIn
  • Twitter
  • Copy URL
Download Letter

Share

As readers probably know, if like me, you are currently living in the UK, you have been in a complete lockdown since the start of 2021, going out only for essential shopping and local exercise.  So, I have found myself with plenty of time for contemplation, but at least events in the markets have been offering plenty of distractions!  For the first time in family history, I was alerted early to an investment issue by my children, in this case the GameStop saga (they are clearly much more in tune with the Reddit zeitgeist than I am).  More recently, the markets and particularly the bond markets have suddenly – arguably belatedly – woken to the possibility of inflation (see my Q3 letter for a slightly more forward-looking perspective).   

Indeed, while our investment teams have been poring over the projected timing and impact of inflation (reference Dr. Sushil Wadhwani’s recent commentary here), my focus is on the longer term and, in particular, I have been fascinated by the continuing acceleration of developments in the ESG space.  I would pick out three interwoven strands at this point in time: 

  1. Global interest in ESG, and particularly the environmental “strand,” continues to accelerate.   
  1. The new Biden administration in the US has seemingly set on a clean break from the policies of the previous administration.  We have already seen that with the US rejoining the Paris Agreement, and all the indications are that we are going to see a much more sympathetic approach to ESG than we had from the US Department of Labor (which “governs” pension plans) previously, which was seemingly putting hurdles in the way of those plans that did want to adopt an ESG approach. 
  1. New European regulations around ESG disclosure in funds are coming into force this month, applying to funds that are used by non-European investors as well. 

I would summarize that we are seeing, simultaneously, an increasing convergence of direction globally and, at the same time, an increasing divergence of what that direction might mean in each region.  Now that can happen in any global enterprise, but I would argue that particularly in terms of ESG and climate, that divergence risks undermining the goals of what our clients, asset managers and our regulators are trying to achieve. 

To start to shine a light on the challenges, I would argue that the right starting place is to consider what our clients who are adopting ESG actually want.  This requires a high level of generalization, but in essence I would summarize that they want to see the behavior of corporations change, although the focus and direction of that change will potentially vary from client to client.  So, for example, if you as a client oppose global warming, your goal is either to get those corporations who emit carbon dioxide to reduce their emissions directly, or to get them to be transparent about their emission activities with sufficient clarity that either the capital allocation process or customer base skews against them to force them to change.  Now, you may also want to use your capital to accelerate development of alternative technologies that reduce CO2 emissions, e.g., hydrogen power or CO2 recapture, but the chain of cause and effect is much easier to influence here; subject to whatever legal and fiduciary constraints they operate under, a client is free to positively allocate capital to these new alternative technologies, should they so choose.  The challenge is how your ESG aspiration as a client works its way through the “system,” i.e., a company with managers on behalf of shareholders and an asset-management industry managing assets for clients, since the system creates a range of agency effects that can obscure your goals. 

What do I mean by “agency” effects?  As a general economic term, these arise when the will of the end user is enacted through agents of any sort and the interests of the agents and hence their potential actions diverge from those of the end user.  Where do I see agency effects in the ESG cycle? 

  • One mode of putting pressure on corporations is via shareholder resolutions.  Management is likely to resist pressure to change strategy, and the fragmented nature of the voting process can make it easier for corporations to resist that pressure, e.g., resolutions need to be permitted to be tabulated, the voting is divided across all the shareholders, and the actual voting process may well be delegated to the investment managers rather than enacted by the asset owners, who moreover may find that rules on market collusion (seemingly not applicable to Reddit participants!) preclude their acting in concert. 
  • If corporations are going to publish data, then, of course, they will naturally prefer to publish data that shows them in a good light. This may be via choosing different start dates, different reference points or focusing on partial disclosures, etc.  Thus, the collective desire to see more comprehensive, more standard data can end up being frustrated. 
  • Managers themselves are in competition with one another, and so will naturally look to score competitive points irrespective of whether in aggregate this benefits our clients.  So, if individual managers choose to compete on having better “secret” data, then actually this can serve to reduce forces on companies to publish better public data. 
  • Finally, we often look to regulators to lay out minimum standards on issues like data disclosure to prevent arbitrage and selectivity by companies.  For general financial reporting, this is underpinned by international accounting standards, for example.  However, if regulators see themselves as somehow in competition, that can create windows for global companies to both play the field in terms of which standards they adopt, and also use lobbying etc. to stoke that competition in a direction that suits them. 

So how can we, as an industry, try and counteract these agency effects to better increase the chances of achieving what both the clients and many, if not all, asset managers want?  Of course, because we are counteracting agency effects, it follows automatically that this may not suit every individual player, but the stakes are too high to let that be a deterrent.  Here is my manifesto! 

  1. Let us, firstly, accept and embrace that ESG will mean different things to different end clients, both within an individual country and even more so globally.  Let us embrace that in our design of our strategies and products – even though it reduces our economies of scale – rather than trying to shoehorn everyone into the same label, which will actually serve to reduce cooperation and create more dissonance. 
  1. Let us look for ways in which we can work together as an industry on issues like engagement and voting, which will help us mitigate the natural fragmentation in the system that serves to reduce our collective voice, and allow end companies to divide us. 
  1. Let us work to avoid proliferation of initiatives, particularly around data, each of which is well-meaning in isolation, but which collectively serve to reduce the pressure on companies to publish abundant transparent data on a consistent basis.  For example, it’s been fascinating to observe the growth in the number of academic bodies that are tying to a particular owner or manager to launch a research initiative on some facet of ESG data and/or its significance.  Given the large number of universities, and large number of clients and managers who care passionately about the subject, this is of course not surprising at an individual level.  However, I would argue strongly that the industry is better served by having two or three such initiatives with multiple backers of each rather than 20 or 30, and certainly that the former is more likely to create effective pressure for changes in behavior, which is, after all, the goal here! 
  1. In a similar vein, let us be careful and thoughtful as individual managers about proclaiming that we have some secretive data source that makes one of us a better ESG manager than another.  At its broadest level, I do not believe our clients are looking to use ESG as an opportunity for gaining alpha (presumably at the expense of someone else who must be “losing”); they literally want a better world for everyone.  Fragmentation of data, which by its nature is the opposite of transparency, only serves to reduce the pressure on companies to change. 
  1. Finally, let us collectively try to increase the pressure on global regulators to find a common voice on and common approach to ESG.  This is an area where we want maximum convergence in terms of what is expected of investee companies, and minimum scope for interpretation and global divergence by those companies.  Again, there may be national fiefdoms in play, but we are generally all aligned here, and any rules that are enacted whether nationally or globally are presumably there to help protect the owners of the assets. Our collective voice surely has weight, if we can find a way to make it heard effectively. 

Of course, your manifesto may be different!  But I do hope you share my view that we should try and address these issues early and cohesively, before we all head off in different directions.  The further apart we allow ourselves to get, the harder it will be to get back together without perceptions of winners and losers.  The underlying paradox is that, potentially, this is an area where the greater the plethora of individual efforts that go in, the less effective we risk being at achieving what we all collectively want! 

Download Letter
  • By Andrew DysonSpecial Advisor, PGIM Quantitative Solutions

More from Andrew

Scenario Planning Helps Emphasize All-Weather Outcomes
Quarterly Letter

Scenario Planning Helps Emphasize All-Weather Outcomes

Jun 28, 2021

Andrew Dyson on the importance of scenario planning and how it might be useful in the current market environment.

Long-Termism – Another Casualty of 2020?
Quarterly Letter

Long-Termism – Another Casualty of 2020?

Oct 22, 2020

Andrew Dyson discusses the problems with widespread short-term investment decision-making and several timely reasons not to lose sight of the big picture.

Beware False Prophets: Focus on the Logic of Value
Quarterly Letter

Beware False Prophets: Focus on the Logic of Value

Jun 25, 2020

Andrew Dyson offers investors a different outlook on the relationship between growth and value factors, a better perspective on the “Is Value Dead?” debate.

For Professional Investors only. All investments involve risk, including the possible loss of capital. 

The comments, opinions and estimates contained herein are based on and/or derived from publicly available information from sources that QMA believes to be reliable. We do not guarantee the accuracy of such sources of information and have no obligation to provide updates or changes to these materials. This material is for informational purposes and sets forth our views as of the date of this letter. The underlying assumptions and our views are subject to change. 

References to specific securities and their issuers are for illustrative purposes only, are not intended, and should not be interpreted as recommendations to purchase or sell such securities.  

For compliance use only QMA-20210316-88

  • About Us

    • Overview
    • Our History
    • The Team
    • Inclusion & Diversity
    • Contact Us
    • Careers
  • Insights

    • All Insights
    • ESG
    • Market Views
    • OUTcomes Series
  • ESG

    • Overview
    • Insights
    • ESG Policy
    • Stewardship and Governance
  • Solutions

    • Overview
    • Quantitative Equity
    • Multi Asset
    • PGIM Wadhwani
    • PGIM DC Solutions
PGIM Quantitative Solutions Logo
  • Terms & Conditions
  • Privacy Center
  • Accessibility Help
  • Cookie Preference Center

For Professional Investors only. All investments involve risk, including the possible loss of capital.

The content and materials presented here are for informational and educational purposes only and should not be construed as investment advice or an offer or solicitation in respect of any products or services to any persons who are prohibited from receiving such information under the laws applicable to their place of citizenship, domicile or residence. PGIM Quantitative Solutions LLC (PGIM Quantitative Solutions or PGIM Quant), formerly known as QMA LLC, is an SEC-registered investment adviser and a wholly-owned subsidiary of PGIM, Inc. (PGIM), the principal asset management business of Prudential Financial, Inc. (PFI) of the United States of America. Registration with the SEC does not imply a certain level of skill or training. PFI of the United States is not affiliated in any manner with Prudential plc incorporated in the United Kingdom or with Prudential Assurance Company, a subsidiary of M&G plc, incorporated in the United Kingdom. 

In the United Kingdom, information is issued by PGIM Limited with registered office: Grand Buildings, 1-3 Strand, Trafalgar Square, London, WC2N 5HR. PGIM Limited is authorised and regulated by the Financial Conduct Authority (“FCA”) of the United Kingdom (Firm Reference Number 193418). In the European Economic Area (“EEA”), information is issued by PGIM Netherlands B.V. with registered office: Gustav Mahlerlaan 1212, 1081 LA Amsterdam, The Netherlands. PGIM Netherlands B.V. is authorised by the Autoriteit Financiële Markten (“AFM”) in the Netherlands (Registration number 15003620) and operating on the basis of a European passport. In certain EEA countries, information is, where permitted, presented by PGIM Limited in reliance of provisions, exemptions or licenses available to PGIM Limited under temporary permission arrangements following the exit of the United Kingdom from the European Union. 

These materials are issued by PGIM Limited and/or PGIM Netherlands B.V. to persons who are professional clients as defined under the rules of the FCA and/or to persons who are professional clients as defined in the relevant local implementation of Directive 2014/65/EU (MiFID II). PGIM Quantitative Solutions, PGIM Limited and/or PGIM Netherlands B.V. are indirect, wholly-owned subsidiaries of PGIM. These materials are not intended for distribution to, or use by, any person in any jurisdiction where such distribution would be contrary to local or international law or regulation.

In Japan, investment management services are made available by PGIM Japan, Co. Ltd., ("PGIM Japan"), a registered Financial Instruments Business Operator with the Financial Services Agency of Japan. In Hong Kong, information is provided by PGIM (Hong Kong) Limited, a regulated entity with the Securities & Futures Commission in Hong Kong to professional investors as defined in Section 1 of Part 1 of Schedule 1 (paragraph (a) to (i) of the Securities and Futures Ordinance (Cap.571). In Singapore, information is issued by PGIM (Singapore) Pte. Ltd. (“PGIM Singapore”), a Singapore investment manager that is licensed as a capital markets service license holder by the Monetary Authority of Singapore and an exempt financial adviser. These materials are issued by PGIM Singapore for the general information of “institutional investors” pursuant to Section 304 of the Securities and Futures Act, Chapter 289 of Singapore (the “SFA”) and “accredited investors” and other relevant persons in accordance with the conditions specified in Sections 305 of the SFA. In South Korea, information is issued by PGIM Quantitative Solutions, which is licensed to provide discretionary investment management services directly to South Korean qualified institutional investors on a cross-border basis.

PGIM, PGIM Quantitative Solutions logo and the Rock design are service marks of PFI and its related entities, registered in many jurisdictions worldwide.

© 2023 PGIM Quantitative Solutions. All Rights Reserved.
 

You are viewing this page in preview mode.

Edit Page