UK fund management industry demonstrates strong progress in ESG risk management in 2021, but improvements are still needed

  • 23% of UK investment funds awarded an XPS green rating for ESG, up from 10% last year.
  • However, greenwashing remains a risk with 26% of equity funds unable to provide any examples of ESG being incorporated into decision making.
  • The findings come from XPS Investment’s ESG ratings Review 2021, which assessed 54 fund managers across 199 funds on their ESG risk management processes.

The results of the review find fund managers have continued to respond to institutional investor demand for better ESG management, with 23% of funds now awarded an XPS green rating for ESG, up 10% from 2020. There are some clear areas of improvement, for example in relation to stewardship by fund managers as well as significant progress in terms of carbon footprint reporting. Notably, fixed income funds were able to most consistently evidence robust integration of ESG compared to other asset classes.

Private markets are beginning to make some headway in factoring in ESG to decisions, albeit from a low base. Last year only 60% of funds referenced ESG in their investment policy, whereas this year all of them did.

Nevertheless, there are some clear areas for improvement, and greenwashing remains a risk. For example, there is evidence found of strong firm-level messages not being backed up by fund investment decision making - 62% of active equity managers scored green for firm-level philosophy, while only 10% were rated green for ESG within the specific fund. Furthermore, we found significant dispersion of scores between asset classes for a given manager, indicating that whilst the overall firm philosophy score may suggest a commitment to considering ESG risks, there was weaker ESG within investment processes in practice.

In addition, we found many funds (11% of all funds, and 26% of equity funds) were unable to provide any examples of E, S or G factors being taken into account in investment decisions, raising legitimate concerns over whether the ESG processes being described are being applied in practice.

To raise standards across the board, XPS believes fund managers should:

  • Commit to robust consideration of ESG and climate change risks into their existing strategies, so that actions in practice mirror the strong firm-level policies.
  • Utilise power as providers of finance through stewardship to drive positive outcomes in companies.

For Pension Schemes the findings here emphasise the need for Trustees to:

  • Take time to clarify their own beliefs and priorities around ESG
  • Challenge their investment consultants to undertake thorough due diligence of their portfolio to ensure ESG practices of their managers are aligned to the scheme’s objectives
  • Engage with managers to ensure effective stewardship
  • Make changes to the portfolio if needed and consider the use of sustainable funds which go beyond the minimum expected standards of ESG integration.

Commenting on the findings Simeon Willis, Chief Investment Officer, at XPS said: “While the findings clearly show that there is a lot more work to do, it is promising to see that fundamental parts of a good ESG strategy are being put in place across the board. Effective ESG risk management must be underpinned by a clear ESG philosophy, and most firms now have this essential foundation in place. But managers must move beyond words to actions for this to matter, and this needs to be consistent across all their funds and be well communicated to clients.”

Alex Quant, Head of ESG research at XPS added: “We are particularly pleased to see private markets begin to show signs of progress when it comes to ESG. It points to demand from asset owners for information and change. As scrutiny continues to grow, fund managers will increasingly be compelled to reveal what they are doing in practice.”