Viewpoint: Let’s talk about responsible investment due diligence on investment managers

Twenty years ago pension funds, and other asset owners, generally weren’t asking about a manager’s approach to ESG and sustainability issues as part of their manager selection, appointment and monitoring. Now this kind of due diligence is fairly standard practice.

This shift from niche to mainstream has brought both progress and challenges. One notable pain point for investment managers is the increasing volume of responsible investment-focused due diligence questionnaires. Completing these can be time-consuming, diverting attention from other responsible investment practices.

As responsible investment (RI) due diligence becomes widespread, it’s useful to reflect on what’s working well and how challenges can be overcome.

The growing number of asset owners assessing how their external managers approach responsible investment is a positive in itself. It is prudent for all investors to ensure that all material factors are considered as part of investment decision-making. Some investors will need to go further to ensure the sustainability and ethical preferences of their beneficiaries are reflected in the way investments are managed.

The vast majority of PRI’s pension fund signatories are now evaluating investment managers on their RI approach. PRI reporting data from 2023 shows that 178 of the 179 pension fund signatories that outsource asset management took this step directly or through their investment consultants. Back in 2014, only around 20 PRI pension fund signatories reported reviewing managers’ approaches to RI as part of the selection process.

“It can be useful for asset owners to provide feedback to investment managers on information provided through due diligence questionnaires”

The nature of evaluations has evolved to become more sophisticated over the years, and the amount of data available to be considered as part of due diligence has increased in response to growing demand. Asset owners are tailoring questions to ask about specific areas of focus and concern. Investment managers now expect to be asked for information on how they consider ESG issues, such as climate change, and prepare accordingly.

Mandatory public disclosure requirements, such as those set out by the EU’s Sustainable Finance Disclosure Regulation (SFDR), combined with voluntary frameworks, such as PRI and regional stewardship code reporting, deepen the information pool further. But navigating this expanding pool of available data is not without its challenges.

What’s not working?

“It’s a flood. It’s a real issue. As an industry, we have to get organised and aim to ask the same questions. My team gets swamped,” said Roger Beauchemin, chief executive officer of Addenda Capital, at the 2024 PRI in Person Conference when commenting on the proliferation of responsible investment due diligence questionnaires.

There is a clear message from asset managers when it comes to responsible investment due diligence: it needs to become more efficient and effective. Multiple questionnaires largely ask the same thing but slight variations in phrasing mean they require slightly different responses each time.

At the PRI, we hear from investment managers receiving questionnaires that are not tailored to their asset class, reducing the quality of information gathered. Equally, it can be unclear to investment managers how the responses they provide to the questionnaires are being used. One commented that sometimes it seems like they’re being stored away in a digital filing cabinet without being properly evaluated.

Asset owners have also shared their frustrations about how investment managers are responding to RI DDQs, describing how they are often filled out by teams not directly involved in investment decision-making, resulting in high-level responses that lack important detail.

How to progress?

It is clear that the increasing volume of requests for information on investment managers’ approaches to RI is creating blockages at multiple points in the process. What steps can be taken to address these issues?

Starting at the top of the investment chain, it is important for pensions and other asset owners to be clear on their RI objectives. Having this clarity ensures only information that is relevant to manager selection is requested. For investment consultants playing an intermediary role, understanding clients’ objectives is key for effectively steering information requests.

“Technology platforms have the potential to drive more efficient processes if effectively leveraged”

As different asset owners have different reasons for engaging in responsible and sustainable investing, the information they request from managers is necessarily going to differ. However, there is a good degree of overlap in the foundational information that is required.

The PRI – often in partnership with other investment industry bodies, such as the Institutional Limited Partners Association – produces a series of responsible investment due diligence questionnaires. These questionnaires are asset-class, issue, or practice specific, and designed to be a starting point for more in-depth conversations between asset owners and managers. They aim to create an aligned industry standard, reducing the need for asset managers to produce duplicate responses to similar questions and provide standardised comparable information for asset owners.

Where resources allow, it can be useful for asset owners to provide feedback to investment managers on information provided through due diligence questionnaires and on their public disclosures on RI.

“As a manager, you want to hear how you’re doing,” says Addenda Capital’s Beauchemin. ”We want to get better. When we’re told ‘you’re doing well’ or ‘this you could improve’, that’s good.”

Karen Lockridge, director of responsible investing at Canada’s CAAT Pension Plan, is also an advocate for two-way dialogue. “The conversations we have with managers, that’s where the real value is,” she says. “The managers have questions for us too. They’re wanting to hear feedback.”

Another element of the equation is technology platforms, which are playing a more important role in how information is collected and distributed. These have the potential to drive more efficient processes if effectively leveraged.

The way pension fund investors and other asset owners are evaluating their managers on responsible and sustainable investment continues to evolve. New pain points are likely to arise as current issues are addressed. All this means it’s important to maintain a continuous dialogue on the topic to keep pushing for improvements.

Eilidh Wagstaff is a senior specialist for multi-asset in the Principles for Responsible Investment’s (PRI) investor guidance team