Inside money managers' scramble to get a grip on socially conscious investing as the Biden era dawns

President Joe Biden's administration has already ushered in wins for climate activists, from rejoining the Paris climate agreement to banning oil companies' leases on federal land.

One set of environmental policies that gatekeepers across the financial-services industry will be tracking closely is how the new administration prioritizes, treats, and defines environmental, social, and corporate governance (ESG) funds through agencies like the Securities and Exchange Commission and the Department of Labor.

ESG-focused funds scooped up record assets in 2020 when twin crises in the pandemic and police brutality against Black Americans pushed investors to reconsider their investments' real-world influence.

Exchange-traded funds and traditional open-end mutual funds in the US with a sustainable focus attracted a record $51.1 billion from investors last year, according to a January 28 report by Jon Hale, the head of sustainability research for the Americas at Morningstar. That marks a significant rise from $21.4 billion in 2019 and $5.4 billion in 2018.

Read more: Bank of America, KPMG, Mastercard, and some 60 other top companies adopt new ESG metrics

As the Biden administration sets out to address climate change more aggressively than the administration under President Donald Trump and looks to more concretely define "sustainable" investments, money managers are scrambling to form sustainable-investing frameworks, create values-based products, and produce sustainability research. 

Otherwise, they risk losing money from a new generation that is set to benefit from a giant transfer of wealth and prizes companies putting money where their mouths are. Institutional investors are also incorporating ESG as part of their manager selection more seriously than they have in past years.

A recent survey that investment consultancy Bfinance conducted of 256 investors responsible for some $7 trillion in assets showed 63% of respondents said they would likely not hire an equity manager who is not a signatory of the United Nations-backed Principles for Responsible Investment.

"I don't have to pretend that I'm doing this for social reasons," Diego Kuschnir, the chief investment officer of Solanas Capital, an ESG-focused fund manager that is part of Leucadia Asset Management, said at a virtual industry conference last month.

"We evolved to do this because we thought it was the most attractive place to generate returns," Kuschnir said during the Context Summits conference, adding companies that are "not on the right side of things are being left behind."

ESG is everywhere even though nobody knows what it is

For years, a lack of consistency in ESG standards has led to skepticism and frustration around whether frameworks to measure investments' "sustainability" are meaningful.

That is something the SEC may finally tackle under its incoming chairman, Gary Gensler, who even after spending nearly two decades at Goldman Sachs into the late 1990s has earned the monikers of Wall Street's "scourge" and "archenemy" for being tough on big institutions.

Former Chairman Jay Clayton has said the matter is important to the SEC. Still, the SEC's Office of the Investor Advocate said in a December report that the securities regulator had "failed to establish a coherent framework" for companies' ESG-related disclosures.

Industry participants believe the new administration could make data standardization a priority, which would open the door for uncertain managers to use an ESG lens.

Read more: How BNY Mellon is looking to fix ESG's data problem and turbocharge the market's record flows

"It's going to be some time before we have regulation and legislation — certainly consistent regulation and legislation — calling for publicly available data from corporations around the world," Suni Harford, the president of UBS Asset Management, said.

"So we're asking for that data today," she said during a virtual event UBS held in late January. "When we engage with a company, we're asking for clear and measurable energy-transition plans from the companies. So through engagement, we can also track a company's progress and hold them to account for the promises that they've made in the market."

Read more: Big investors like Apollo and Carlyle are clamoring for a piece of the $30 trillion ESG space. We spoke to 15 insiders about how they're ramping up hires, raising money, and striking data-driven deals.

"A universal framework will help create a little more consistency in how this is done," Dan Mistler, the head of the newly created global ESG practice at the New York consultancy ACA Compliance Group, said.

"It is true that there is no hard regulation here in the US. But I think of it as pseudo-voluntary," he said in an interview. "So many investors are looking for this. It has evolved and matured and has become an expectation for investors."

Money managers' dash to create new ESG roles, rules, and tools 

BlackRock CEO Larry Fink, who runs the largest investment manager with $8.7 trillion in assets as of December 31, has been particularly vocal in calling for companies to embrace sustainability as a concept.

"We encourage the companies our clients are invested in to operate with a long-term mindset, increased transparency, and important sustainability factors and focus on all of their stakeholders, and this is driving BlackRock's performance," he said last month during a call with analysts to discuss earnings.

That day, BlackRock said it had taken a minority investment in Clarity AI, a 4-year-old fintech startup founded by a former Santander executive that specializes in analyzing sustainability factors.

"We are far from a place in sustainable investing where everyone has the same information. It's a matter of what you do with it and how you look at it differently," Mary-Catherine Lader, BlackRock's head of Aladdin Sustainability, said in an interview with Insider, referring to the industry broadly.

"We're still in a phase where having the right sources of information and the right volume of information is still really important in differentiating, in addition to how you look at it and how you think about what matters," she said.

Read more: From 'temperature aligned' investment products to outlining a plan to reach 'net zero,' here are 4 highlights from Larry Fink's letters to CEOs and BlackRock clients regarding ESG

BlackRock is seen as a trendsetter in the space as the largest money manager and ETF provider. And with his influential annual letters to fellow chief executives and clients, Fink has styled himself as a source of counsel and unofficial leader in doling out advice on crises like climate change. BlackRock's influence extends to the many outside investors paying to use Aladdin, too, since they use the firm's ESG measurement tools while examining portfolio risk.

Fink said in his most recent letter to CEOs that the firm "strongly" supported a single global standard of companies' sustainability disclosures and urged "companies to move quickly to issue them rather than waiting for regulators to impose them."

Still, environmental activists say BlackRock has not done enough to fight climate change.

BlackRock said it aimed to remove the public debt and equity of companies that generate more than one-quarter of their revenues from thermal coal production from its discretionary active portfolios by mid-2020. The same cannot be said for assets invested through passively managed funds tracking indexes that include such companies, and the firm managed $85 billion in assets tied to coal companies as of October, the activist nonprofit organizations Reclaim Finance and Urgewald said in a report last month.

BlackRock has said it works with companies' management teams on encouraging progress in disclosing and managing sustainability risks and that the firm will "hold them to account through proxy voting if they are not," Fink said last year.

Every major investment manager is looking to address clients' demand for sustainable strategies, and several have come out with new ESG-focused tools this year.

QMA, a quant arm in Prudential's vast asset-management unit, launched an ESG-focused separately managed accounts platform for registered investment advisors this week. Andrew Dyson, the CEO of QMA, said the new platform was in response to the demand for ESG, which he said he believed had been stifled in the US by the Department of Labor and policies.

The department's long-awaited fiduciary rule was put on ice by the Trump administration but is expected to be revived by Biden and his team. When the rule was formulated by President Barack Obama's Department of Labor, the agency made it clear that ESG factors being used in investment decisions could be considered a breach of a fiduciary duty because the department did not consider the factors to be entirely returns-focused for the end investor.

"I'd like to see that demand unsuppressed," Dyson said.

Last month, Fidelity said it was launching a tool to help advisors figure out which mutual funds and ETFs they should invest in based on ESG research, pointing to demand from millennials and Generation Z investors for ESG-focused investments. The financial-services tech giant SEI said earlier this month that it would offer a similarly ESG- and customization-minded tool for advisors looking for sustainable-investment screening.

Expectations for the new administration

Biden's administration has the sort of pedigree for tackling climate change that other administrations have not had. Brian Deese, BlackRock's former global head of sustainable investing, is leading Biden's National Economic Council, effectively serving as his top advisor on economic matters.

Before he joined BlackRock, Deese was a senior advisor to Obama on climate and energy-policy matters and helped negotiate the Paris agreement.

Some in the industry expect the new administration to engage more aggressively than in the past on ESG matters. 

"Look, I know Janet Yellen pretty well," UBS Chairman Axel Weber said during the January 28 call the bank held, responding to a question from Insider about what action he expected from the new administration on ESG.

Weber, who lives in Zurich, said he had been "waiting for the American administration to join the global effort on moving to sustainability" and praised the Treasury secretary's work on a recent sustainable finance report she cochaired with Group of Thirty, the international group of finance and academic leaders.

Read more: How the boom in socially conscious investing is influencing the way massive corporations react to events like the Capitol riots

"They certainly see this as an opening, this new administration," Brian Guzman, the founder of the law firm Guzman Advisory Partners, said of the industry's ESG ambitions in general.

Gary Gensler
Alex Wong/Getty Images

But a flood of money always leads to players attempting to pry off a chunk without putting in the work.

The practice of greenwashing — dressing your fund up as ESG or sustainable without really using the factors — is well known to industry participants and regulators, but without a true definition of ESG, it can be hard to call out.

"Some kind of standardization of it would be really helpful," said Rob Fernandez, the director of ESG research at Breckinridge Capital Advisors, a $44 billion fixed-income manager based in Boston.

"Firms are integrating these considerations in different ways, but we've been doing this awhile now and feel that there are some best practices," he added. "It feels like this should be coming from the SEC."

For more adoption, it all comes down to data

Andrew Collins has thought about ESG data for a good chunk of his career now. The director of ESG and responsible investing at San Francisco Employees' Retirement System, Collins previously worked at the Sustainability Accounting Standards Board, where he was the lead author on the agency's 77 industry standards for public companies to disclose. 

The conversation around data — which he calls ESG's "big challenge" — often misses the point, as frustrated asset managers point to ratings agencies' disparate rankings of the same company or sector.

To Collins, that's the difference between ESG data and ESG information — a rating or scorecard is information, and it's the opinion of the ratings agency. "I don't know if we'll ever get uniformity in these scores," he said at the Context Summits conference. ESG data, meanwhile, would be information directly from the source — a company disclosure of its emissions, for example.

The data the ratings agencies are building the scores off of needs to improve and become more standardized, but Collins believes there's "light at the end of the tunnel" with the new administration, he said.

"Hopefully that playing field is level for all these different entities to then apply their own judgments on top of," he added. 

James Rasteh, the founder of the $250 million hedge fund Castle Capital, believes uneven data means active managers have to prove their worth as investors, he said. He invests primarily in what he considers to be a generally unclean industry — mining — with an ESG lens. 

His firm focuses on working with mining companies and pressuring them to adopt cleaner standards instead of just ignoring the industry altogether, which he worries will happen if ESG data becomes more standardized and widespread.

Read more: Meet the rising stars who are taking on the $1.9 trillion energy industry and cleaning up the electrical grid 

"It's the lazy man's way of thinking about ESG," he said about widespread data harmonization.

People need to understand their companies and the industry better, or else entire industries could be ignored by investors like Rasteh and left to passive managers who don't care about environmental protections.

"This is a complicated topic, and a blanket policy is a simple policy," he added.

Either way, the data is too important to investment managers to be left unaddressed. 

Sandra Myburgh, the founder of the New York investment manager FERN Impact Partners, put it more directly: "If data is the new oil, then we need to get it right."