Environment, social and governance (ESG) has in recent years become a top priority for the asset management industry. In this paper, we look at why this has happened and what it means for investors investing in real estate funds and their fund managers.

Why is ESG considered important?

Whereas previously ethical investment may have been viewed as morally virtuous, it is now also being seen as a financially sound investment in its own right, as well as one that promotes values and ideals that form the basis of many firms. The COVID-19 pandemic has accelerated the elevation of the importance of ESG performance.

Evidence suggests that having ESG considerations integrated into a strategy of a fund leads to a better performance. This may be because reputational, financial and operational risks are mitigated.

Investors, many of whom have signed up to reporting their own ESG performance and need to demonstrate to their stakeholders or regulators their commitment to key principles, require a strong ESG policy from the funds in which they invest. A commitment to ESG needs to be embedded in the fund strategy and not treated as an optional "add-on" or a box-ticking exercise.

It needs to be an integral part of a fund's approach to investment and its business model i.e. baked into day-to-day operations and business practices, processes and systems.

Investors in real estate will look at the role played by the property they indirectly own – is their investment having a positive impact on the community and the wider environment?

How to investigate ESG impact?

Due diligence investigations on the ESG impact of real estate investments will look at a variety of issues, including climate change strategy; employee welfare; supply chain process; political lobbying; health and safety records; diversity and inclusion; and impact on nature.

Managers need to make sure that the portfolio companies in which they are investing are able to disclose and report on an ongoing basis in a transparent manner that suits investors.

How to report on and measure ESG performance?

There are a number of organisations that issue standards for ESG performance disclosure.

Investors will look at those funds participating in surveys distributed by these organisations, analyse the results and consider them as part of their investment decision. If a fund manager declines to respond to a survey, then it risks being passed over by prospective investors. As more funds disclose ESG performance, so the data being produced improves and the competition intensifies amongst funds to achieve high standards.

Different sectors will focus on different ESG issues e.g. for real estate the area of sustainability will be an important metric. It is clearly challenging finding consistent methodology that can be applied across different types of assets in different regions. Benchmarking is also critical, allowing investments to be compared and meaningful global and regional insights to be revealed. It can also allow for tracking performance against goals set in international policy such as United Nations Sustainable Development Goals. However, this is not a straightforward task and some in the industry think standardisation will take at least two years to achieve.

Concluding thoughts

Fund managers in the real estate sector need to recognise investor demand for transparency and clarity in reporting ESG performance of funds and their investments. The onus is on managers to engage with investors and find the right disclosure model for their needs. Continued reporting and disclosure will help deliver a sustainable future, whilst benefiting a manager's own business through having an empowered and proud workforce, delivering financially successful products.