Much is made of the ESG growth opportunity. But evaluating the ESG credentials of asset managers can be hard. Citi Research’s ESG Focus Framework provides investors with a tool to answer the key question of which European manager(s) are best placed to generate ESG flows.
Global ESG assets under management have increased at a 63% compound annual growth rate since 2017, while flows into ESG funds are up 78% year to date, per EPFR data. With structural growth drivers intact, Citi’s Research analysts expect medium-term growth to remain strong. Some estimates suggest that ESG AuM will increase threefold by 2025.
Citi’s ESG Focus Framework
Citi’s analysts have taken an in-depth look at European asset managers’ firm-level ESG credentials by analysing the huge quantity of public disclosures to evaluate which managers best evidence ESG culture and are best placed to benefit from ESG structural growth. The proprietary quantitative ESG Focus Framework compares asset managers across 50 criteria from five key themes, including AuM and performance, stewardship, governance, climate, and diversity to provide investors with a broad view of their ESG focus.
The ESG Asset Manager of the Future
Citi’s analysts found that the ESG asset manager of the future will be one with full ESG integration across the product suite and a clear and strong responsible investment policy applying to all mandates as standard. It will also have a broad ESG offering with full customization, enabling clients to achieve portfolio solutions for specialized, E, S, or G objectives. A strong ESG culture is evidenced through explicit ESG targets (not just on 2050), aligned compensation throughout the organisation (not only senior management), with asset managers leading by example in terms of diversity and operational efficiency. It is also demonstrated through high levels of engagement across E, S, and G, with an aligned voting policy and a sustained track record for supporting ESG resolutions.
Sustainable and RI Strategies Continue to Grow (2016-20) |
But Stricter Definition of RI Assets Suggests That They Comprise a Small Proportion of Global AuM |
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*Decline in Europe and Australasia due to material changes to definition of sustainable investments |
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Source: Global Sustainable Investment Review 2020, Citi Research |
Source: EPFR, Citi Research |
Citi’s analysts note that asset managers that can demonstrate a strong focus on ESG (in terms of products offered, governance structures, and integrated ESG analytics) should be better positioned to benefit from the growth tailwind and therefore report stronger flows.
In deriving the criteria, Citi’s analysts acknowledged the Investment Association’s Responsible Investment Framework, which covers three firm-level components: 1) stewardship, 2) ESG integration, and 3) exclusions. This framework was then expanded to cover the following:
- Overall ESG AuM, ESG ratings by select third parties, and investment performance of ESG funds (c30% weighting);
- Stewardship (c30%);
- ESG integration, including governance and incentives structures (c15%);
- Approach to climate change (c15%); and
- Approach to gender diversity (c15%).
With so many different aspects to ESG investing, a clear issue is how to weight the relative importance of each of these aspects. Citi’s ESG focus framework assumes a double weighting for each of AuM and Stewardship factors, given that it considers the following:
- ESG-certified AuM and analysis/ratings by third parties, such as UNPRI, to be indicative of ESG focus, and
- Stewardship, which is important, as it is a fundamental role for asset managers.
Accordingly Citi assigns these two criteria c30% weight in the framework versus 14-15% across other criteria.
Next, we highlight one of these aspects, namely performance.
ESG Fund Performance
Investment performance has declined over time. Among the various reasons for this decline are the following:
- increasing professionalisation of markets, as illustrated by the increasing number of CFA charter holders;
- increased availability of data, making it hard to sustain a competitive edge; and
- de-equitisation of markets, with a falling number of listed companies reducing the set of investment options (Vanguard noted that US publicly listed companies almost halved from 7k in 1996 to 3.8k in 2016).
Alpha Generation Declined from c9% to 0% Over the Past 20 Years |
De-Equitisation Has Become Increasingly More Significant |
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Source: Citi Business Advisory Services. Industry Revolution Series Part I: The New Building Blocks: Moving Beyond Equities and Bonds (2018) |
Source: Citi Global Equity Strategists: De-equitisation: Why Markets Are Shrinking And What It Means (May 2019) |
Investment performance has long been a key criterion for selecting asset managers. In this context, deteriorating performance increases commoditisation risks and drag on industry assets, particularly when competition from alternatives and passive asset management is increasing.
Looking forward, Citi’s nalysts expect performance to become relatively less important (than in the past), as asset owners increasingly seek to partner with asset managers that can help to achieve specialised ESG objectives. To be clear, they expect performance to remain important, but with ESG capabilities becoming more important, this will reduce the relative importance of performance. For more on the other aspects of this proprietary framework and this subject more broadly, please see European Brokers & Asset Managers - Hunting For The ESG Asset Manager Of The Future, published on 6 January 2022.
Citi Global Insights (CGI) is Citi’s premier non-independent thought leadership curation. It is not investment research; however, it may contain thematic content previously expressed in an Independent Research report. For the full CGI disclosure, click here.
