Capturing and Evaluating Intentionality in Funds

One of the most salient themes in this year’s 29th Annual SRI Conference was intentionality. The topic of intentionality has jumped to prominence in ESG discussions—particularly in regard to ESG ratings for mutual funds—and understanding what it means is important for ESG market participants.

In ESG terms, intentionality aims to evaluate whether a given fund or strategy has policies and procedures in place that demonstrate that the investment management process makes a concerted effort to address environmental, social, and governance issues.

Recently, fund analytics and financial information providers began to assign ESG ratings to over 34,000 funds using their proprietary scaling mechanisms and scores. Such methodologies involve a holdings-based scoring system of rolling up individual companies’ ESG ratings into a single mutual fund rating.

The reception to this type of ESG ranking for funds has been mixed, with criticism centering around the fact that the fund’s sustainability score fails to fully capture the ESG intentions of that strategy. In particular, the key concern has been that a holdings-based approach does not take into account the full arsenal of tools available to portfolio managers and investors, such as investor engagement and shareholder proposal voting.

Another criticism directed toward the rolling up method is the lack of consideration for the overarching strategies of the institution (i.e., intentionality) and the limitation in using data-based “snapshots” of funds’ holdings in isolation. For example, the situation may exist whereby a fund has invested in and is working with low ESG score companies in an effort to improve their behavior. Yet in the current scoring system, despite this particular fund’s intention to promote ESG, this fund would register as a low-ranking ESG fund. With this is mind, melding a fund’s intentionality score with the quantitative holdings data would be the preferred method in rating a fund on its ESG performance.

Therefore, the question then becomes: what would be the best way to craft an intentionality score that encompasses a qualitative and quantitative lens for the fund manager? Although there are no easy answers to that question, it has been suggested that an intentionality score should ideally focus on the past actions of the fund and review how managers have voted historically on environmental or broader ESG resolutions at major companies.

Given these concerns about a fund score based on holdings, competitors for mutual fund ESG ratings are introducing methods that are more contextualized and nuanced. For example, some providers rank funds by their initiative on ESG strategy (depth and performance), shareholder engagement, public sphere advocacy, and performance.

It is important to note that these discussions and critiques around the existing methods to evaluate intentionality highlight the transition that ESG is undertaking as it evolves from emerging to mainstream status. The mainstreaming of ESG data into fund rankings is a positive development, as discussions have moved from pinpointing the weaknesses in a company’s ESG data to those at the fund level.

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