This article first appeared in Sustainable Investment: https://www.sustainable-investment.com/opinion/4052307/fund-management-teams-operating-sfdr
Sustainability disclosure and client demand is fundamentally changing how fund management teams operate. Here's how.
SFDR has had more of an impact than any other regulatory-driven change asset managers have seen in recent years.
Now that over a year has passed since its first implementation in March 2021, we are in a position to assess the regulation's impact, particularly in relation to how fund management teams operate.
SFDR: A Crucial Distinction
When looking at how these regulations have altered desk or asset management team structure, it is important to first recognize the material differences between Article 8 and Article 9 funds.
Where Article 8 funds need only show that they have considered ESG factors and concepts when designing their investment strategy, Article 9 funds must go further, clearly stating objectives of how the product will deliver positive environmental and/or social impact.
Funds that have been set up expressly to deliver measurable impact tend to already have the processes, human capital and fee structures in place to report to clients on the companies in which they are investing. For these Article 9 funds, which were designed from the outset to deliver impact with a definitive theory of change and clearly defined process and plan, SFDR has not prompted a significant shift in behaviour in team disciplines and skillsets - since this was baked in from the start.
For the more traditional funds seeking to demonstrate Article 8 or 9 compliance, there has been a greater debate and, in most cases, significant changes in behaviour and the kinds of talent being incorporated in investment teams and the wider organizations who support and market those funds.
Adjusting to fund labelling is no easy feat. At an organizational level, ensuring funds are compliant takes time, effort, and eats into margins. As companies adjust to the new regulations, we have noticed an increased demand for specialist recruitment support from investment teams, centralized ESG teams, distribution and compliance functions. This is a clear response to the regulation and client demand, and one that changes the very fabric of the talent you would traditionally find sitting within a fund management team.
To quickly adapt, firms have upskilled and hired investment analysts and fund managers with the skill sets and prior experience required to fully integrate ESG and impact methodologies into their investment processes.
Larger asset managers and private market investment groups have often got there faster, being able to build out centralized teams to carry out bespoke research as well as stewardship and engagement work at a company level (which can in turn be applied by investment analysts for specific products).
Central teams are now more commonly relied upon to deliver the data feeds (both off the shelf and bespoke ESG factors) to investment analysts as well as advise on policy and regulatory changes that need to be factored into product development and distribution strategies.
For many boutique active managers, the SFDR regulation signified a bureaucratic challenge. Although many of the high-quality boutique firms have, for years, been successfully and responsibly investing in a way that aligns to Article 8, they do not have the operational capacity to fill out the various additional documentation proving their ESG credentials for bespoke client reporting and regulatory compliance.
This plays to the advantage of the larger managers, who can dedicate a significant proportion of their sustainable investing/ESG teams time to respond to client requests and more onerous RFP processes.
These adjustments fundamentally apply to Article 8 funds. For Article 9 funds, investment teams rarely get away with outsourcing such activity. It would undermine the qualifying characteristics of an Article 9 fund to have a centralized team engaging with these issues or reviewing activity post haste. To be Article 9 compliant, you need to evidence how your investment strategy was designed for impact, as well as how that is delivered by the investment process itself. People often sit at the heart of this evidence.
The Evolution of Skillsets
In order to understand companies in a more rounded way while also being able to communicate their impact, fund managers must today expand their toolbox, and be able to discover and evaluate these additional insights that are critical to the investment process for these strategies.
The introduction of Article 9, and more sophisticated client demands, has required managers to demonstrate a far more holistic understanding of the companies in which they are investing and the relationship that the business models of these companies have with the socio-economic landscape in which they operate. Messaging and reporting to clients is no longer just about sharing holdings and returns, investors want to see how their capital is delivering non-financial, positive outcomes. As a result, fund managers need to not only follow a thorough due diligence process but also constructively communicate with investee companies to encourage a change in operations to demonstrate additionality to clients.
For funds seeking to demonstrate outcomes beyond financial performance, the manner of how fund managers engage with companies, particularly in public markets, where engagement is often seen as a principal driver of impact. Unlike before, when agendas centered principally around financials, fund managers today are more often expected to anticipate and discuss a wider range of risks and opportunities in their conversations with company management. Often we see this in the way their investment process evaluates how companies can evolve their business model to deliver financial returns while also improving sustainability themed/impact driven KPI's, that be externally verified, as a function of scale.
What does this mean for the jobs market? We are seeing ever increasing demand for individuals with skill sets and experience that has not previously been seen in key roles on the buyside. In some cases, these candidates do not even come from financial services at all. They bring experience in a range of areas including earth observation data/geospatial mapping, natural capital, biodiversity and social equality research, carbon markets, corporate sustainability and climate risk modelling - all with skills that enrich any manager's depth of insight.
What Difference Does it all Make?
All sectors and services need to collaborate to create a more equitable socio-economic system and offset some of the worst impacts of climate change. For the buy side, this means broadening the talent within, and composition of, the breadth and diversity of human capital within the sector.
If a buyside firm is seeking to offer clients the opportunity to invest in companies that are contributing to a future that is more sustainability aligned, or companies that are delivering positive impact, then they need to carefully consider the skillsets and structure of both its investment teams and the wider organisation.
Operational offsetting and short-term, reactive window-dressing will not stand the test of time. It is time to respond to market opportunities, recent regulations and client demands by embracing new, unorthodox skillsets that will revolutionise the capabilities of investment firms to deliver long term value to investors and society as a whole.