Sustainable Investment Mercer ESG Ratings

Mercer’s ESG Ratings

Mercer’s global manager research team evaluates more than 4,400 investment manager strategies on their integration of ESG factors, and active ownership (voting and engagement). This provides Mercer’s clients with a consistent and robust way to evaluate how managers approach ESG and active ownership; then assess how this contributes to their own investment outperformance.

How It Works

When Mercer researchers review a strategy, they will determine an appropriate ESG rating. This rating sits alongside the traditional alpha ratings (A, B+, etc.) and is considered alongside all other relevant factors.  Maintaining such ‘parallel’ ratings:

• Instils a disciplined process to embed ESG questions into Mercer’s core research process and make the responses visible within that process.

Provides a unique ESG marker for the growing client demand for an independent assessment of current or prospective ESG integration and stewardship practices by managers.

• Enables client portfolio comparisons with the Mercer manager universe at a point in time.
• Tracks ESG integration progress across the Mercer manager universe by asset class over time.

Each rating is a qualitative assessment of the depth of ESG integration throughout a strategy’s process, following Mercer’s Four Factor Framework.

• Idea Generation (e.g. risks and opportunities identified)
• Portfolio Construction (e.g. identifying whether ESG views are translated into portfolio positions)
• Implementation (e.g. evidence of active ownership, turnover, time horizon and so on).
• Commitment across the manager’s firm to ESG issues

There are four ESG ratings categories ranging from ESG1 (the highest rating) down to ESG4 (the lowest rating). For a strategy to be assigned an ESG1, the investment team must have demonstrated market-leading capabilities in integrating ESG factors and active ownership in some or all of the four factors. An ESG4 undertakes little or no integration of ESG factors or active ownership into core processes. 

Approximately 17% of ESG-rated strategies receive the highest ratings of ESG1 and ESG2, and the chart below shows the range of ESG integration across the major asset classes:

Distribution of 4,400 + Mercer ESG ratings

This distribution of ratings has shown some improvement since Mercer started evaluating ESG integration in 2010 (initially from 2008 at a fund level) and as the number of strategies evaluated has grown. The current distribution suggests that the industry still has considerable room for improvement, though there continues to be innovation from managers across asset classes and regions.

Learning by Example: What Are the Leaders Doing?

Mercer’s approach to evaluating ESG integration into core investment processes discourages ‘box ticking’ or prescribing a ‘one size fits all’ model. Rather, we look for an indication that managers have made an effort to integrate ESG factors into their alpha generation process as well as beta enhancement by exercising their ownership rights.

Whilst practices vary, highly-rated strategies often have the following common features:

• A demonstration that ESG factors feature in investment teams’ decision making process and corporate culture.
• An effort made to build ESG factors into valuation metrics, using the investment team’s own judgment about materiality and time frames.
• A long-term investment horizon and low portfolio turnover.
• Ownership policies and practices that include sufficient oversight, integration with investment decision-making and transparency.
• For alternative assets, evidence of pursuing best practices in transparency and evaluation, monitoring and improvement of ESG performance as relevant for portfolio companies and sectors.
• A demonstrated willingness to collaborate with other institutional investors to improve company, sector or market performance.
• A commitment to ESG integration across the organisation.

What Can You Do, How Can Mercer Help?

Mercer can help you answer these five critical questions:

1. Do you have a strategy for assessing integration of ESG factors?
2. What are the key ESG performance indicators?
3. Are there specific targets for improvement?
4. What will you do to improve ESG performance over time?
5. If you’re a signatory to the Principles for Sustainable Investment, how have you met your obligations to integrate ESG factors in investment decisions and investment governance?

     

   As an asset owner, you need to ask yourself a few more:

   
   
6. Have we clarified our expectations by revisiting our investment beliefs and policies?
7. Have we formalised ESG and active ownership expectations into requests for proposals and investment manager agreements?
8. Have we built ESG and active ownership expectations and metrics into our measurement and reviews of consultant and fund manager performance?

Mercer can help you answer these questions.