An investment management agreement (IMA) is the legal contract that governs the relationship between an asset owner and a fund manager. For ESG-aware mandates, this document needs to go considerably further than a traditional IMA. It must translate the client's investment beliefs into enforceable, observable commitments, commitments that a manager can actually deliver against and a client can actually test.
What Goes into an ESG-Aware Mandate
An ESG-aware mandate must translate philosophy into enforceable rules. It generally covers four key areas:
- Monitoring ESG Factors: Exactly what data sources the manager must use and how risks are tracked.
- Investment Integration: The actual rules. For example, "carbon intensity must remain 20% below benchmark," or "companies with severe controversies require special sign-off."
- Stewardship Expectations: Clear instructions on how the manager must vote and engage with company boards on the client's behalf.
- Reporting Requirements: The frequency and format of updates, including hard data on portfolio ESG scores and engagement outcomes.
The mandate is a tool for accountability. A vague promise to "consider ESG where relevant" is impossible to enforce. Specific rules and required reporting ensure the manager actually delivers.
Hard Constraint Clauses
Mandates increasingly include specific hard constraints, non-negotiable requirements written into the legal document. A hard constraint might read: "The portfolio shall maintain at least 20% exposure to companies with SBTi-validated Science Based Targets." Unlike soft guidelines, hard constraints are binary: either the portfolio meets them or it does not. They leave no room for managerial discretion and give the client a clear, testable standard against which to hold the manager accountable.
The Request for Proposals Process
To hire a manager, asset owners issue a Request for Proposals (RFP). This detailed questionnaire is how clients evaluate and shortlist potential managers.
Today, RFPs probe deeply into a manager's ESG capabilities. The process usually has two stages:
- The Written RFP: Screens candidates based on their stated policies, team structures, and integration methods.
- The Interview (Beauty Parade): The owner formally interviews the shortlisted managers. This is where clients drill down into specific portfolio decisions to see if the lived reality matches the written promises.
The Role of Investment Consultants
Asset owners, particularly smaller pension funds and endowments, rarely run RFP processes alone. Investment consultants such as Mercer, Willis Towers Watson, and Aon act as gatekeepers to the mandate pipeline. They maintain manager databases, design RFP questionnaires, score responses, and advise trustees on shortlisting. For many managers, these firms are the primary route to accessing institutional mandates.
This gives consultants significant influence over ESG standards. When a leading consultant embeds rigorous ESG questions into its standard RFP template, every manager seeking institutional business must engage seriously with those questions. Consultants have increasingly done exactly this, their own responsible investment research teams assess and rate managers' ESG capabilities, creating an additional layer of market pressure toward substantive ESG integration.
The PRI Standard Due Diligence Questionnaire
The PRI has developed a standardised Due Diligence Questionnaire (DDQ) for ESG manager assessment. The DDQ is designed to be used at the RFP stage, providing a common framework that allows asset owners to compare managers on a consistent basis. Questions cover investment philosophy, ESG integration processes, stewardship, team structure, and reporting capabilities.
The DDQ's value lies in standardisation: it reduces the risk that managers game bespoke questions and makes cross-manager comparison more reliable. Many large asset owners incorporate the PRI DDQ directly into their RFP processes, or use it as the basis for their own customised questionnaire.
Think of the RFP as a structured job application, and the beauty parade interviews as the interview round. The application form screens for basic qualifications and asks candidates to set out their approach on paper. The interview is where you probe the answers, challenge inconsistencies, and try to get behind the polished language to the actual process. The best clients identify specific holdings or decisions in the portfolio and ask the manager to walk them through the ESG thinking, because it is very hard to fake competence in a detailed case-by-case discussion.
What Clients Are Looking for in ESG Due Diligence
When assessing a fund manager's ESG capabilities through an RFP, sophisticated asset owners are looking for confidence across five dimensions:
- That the ESG integration approach is genuinely robust and capable of delivering an appropriate portfolio structure, not just a marketing overlay.
- That the manager can deliver with certainty any hard constraints specified in the mandate (such as exclusions of specific sectors).
- That the manager has the capacity and capability to engage effectively with investee companies on material ESG issues.
- That the manager actually does in practice what it claims to do in policy documents, consistency between stated approach and observed behaviour.
- Underpinning all of this: that the manager has a genuine, deeply-held ESG philosophy, not just a bolt-on ESG team. A sincere philosophy provides the greatest confidence that ESG activity will be sustained consistently over time, not abandoned when short-term performance pressures intensify.
Asset owners and their consultants use structured questionnaires to test stewardship quality. Questions typically cover three areas:
Understanding the manager's stewardship philosophy:
- How long-term is the firm's investment mindset? How is this reflected in portfolio turnover and engagement approach?
- How does the manager decide on the resourcing given to stewardship? How is that resource shared across portfolios, asset classes, and geographies?
- For which asset classes does the manager believe it most needs to improve its stewardship approach, and what is being done?
Testing the processes for setting and tracking engagement objectives:
- What systems does the manager have for capturing engagement objectives systematically and measuring progress against them?
- If different teams within the firm hold the same company, how is stewardship coordinated across those teams?
Understanding how engagement resource is allocated:
- What form of engagement consumes most of the manager's engagement resource?
- What is the process for escalating an engagement that is not progressing? What escalation tools are available?
ESG Integration Across Asset Classes
One of the more practically complex aspects of mandate design is that ESG integration looks quite different depending on the asset class. The table below summarises how mandate design, investment integration, and engagement considerations vary:
| Asset Class | Mandate Considerations | Investment Integration | Engagement Scope |
|---|---|---|---|
| Passive / index | Benchmark design and any ESG tilts or exclusions | Limited manager discretion on stock selection | Engagement and voting can still exert company influence |
| Active equity | ESG-oriented mandate options (e.g. sustainable equity) | Material ESG factors incorporated into company valuation | Engagement and voting on governance, E and S issues |
| Active fixed income | Green bonds; broader fixed income mandate with ESG overlay | ESG risks can affect credit ratings and repayment capacity | Engagement with bond issuers on material ESG risks |
| Real estate | E or S objectives built into mandate | Environmental and social risks during acquisition, operation | Engagement with tenants and local communities |
| Infrastructure | Portfolio bias toward sustainable infrastructure | Physical and societal risks; long investment horizons amplify systemic issues | Influence through governance arrangements (e.g. board seats) |
| Private debt | Mandates targeting sustainable lending activities | ESG risk identification and mitigation during due diligence | Ongoing dialogue with borrowers on emerging ESG risks |
| Private equity | Manager screening for ESG exposure in target companies | Systemic risks; ESG due diligence during acquisition and ownership | High influence over management; governance improvement |
Passive mandates are often mistakenly assumed to have no ESG component. This is wrong. While a passive manager cannot exclude a company from an index simply because of its ESG profile, mandate design still matters greatly: the choice of index benchmark (standard, ESG-tilted, or ESG-screened), the application of any exclusion overlays, and the stewardship and voting programme all create meaningful differentiation between passive managers.
Regulatory Benchmarks for Passive Mandates
For passive mandates with climate objectives, the EU has introduced two regulatory benchmark standards that provide defined criteria:
- EU Climate Transition Benchmarks (CTB), designed to decarbonise the portfolio at a rate consistent with a broad climate transition pathway, while remaining close to the standard index in composition.
- EU Paris-Aligned Benchmarks (PAB), more stringent; require greater carbon reduction from the outset and must align with a 1.5°C warming pathway.
Both benchmark types must meet minimum standards set by the European Commission, including specific exclusions (coal, oil sands, controversial weapons) and annual decarbonisation requirements. For asset owners with net-zero commitments, specifying a PAB or CTB benchmark in a passive mandate is one of the clearest ways to ensure the index itself embodies the climate objective.
Think of a passive mandate like filtered air conditioning. You don't choose where the air comes from, that's determined by the index, just as outside air is determined by geography and season. But you do decide which filters to install. An ESG-tilted or CTB/PAB benchmark is the filter: it ensures that even though the manager has no stock-picking discretion, the result that reaches the portfolio meets your quality standards.
The CFA Institute ESG Product Classification Framework
For asset owners comparing ESG products, the CFA Institute has defined six product types that map to different client needs:
| ESG Product Type | Description | Typical Client Need |
|---|---|---|
| ESG integration | Explicit inclusion of ESG factors in financial analysis and portfolio construction | Clients seeking to capture ESG-related risks and opportunities without restricting the investable universe |
| ESG-related exclusions | Systematic removal of companies or sectors based on ESG criteria | Clients with ethical red lines or reputational constraints |
| Best-in-class / positive alignment | Overweighting companies with superior ESG profiles relative to peers | Clients who want ESG quality without sector exclusions |
| ESG-related thematic focus | Concentration in specific ESG themes (clean energy, water, gender diversity) | Clients with a defined sustainability objective or strong belief in a specific transition |
| Impact objective | Investments made with an intention to generate measurable positive social or environmental outcomes | Clients seeking demonstrable real-world impact alongside returns |
| Proxy voting / engagement | Active ownership used as the primary ESG lever, rather than portfolio construction | Clients who prefer influence over divestment; long-term stewardship investors |
Tailoring the ESG Approach to Different Client Types
Different clients arrive at ESG investing through very different doors. Understanding a client's driver for ESG engagement is essential for matching the right approach to their needs.
| Client Type | Investment Horizon | Primary ESG Driver | Risk Mindset | Favoured ESG Approach |
|---|---|---|---|---|
| Defined benefit (DB) pension | 10-70 years | Fiduciary duty to beneficiaries | Long-term; higher risk tolerance | ESG integration across asset classes |
| Defined contribution (DC) pension | 10-70 years | Fiduciary duty; beneficiary preferences | More risk-averse (members can switch) | Some exclusions; ESG integration |
| General insurer | 1-2 years | Awareness of financial impacts | Loss aversion | ESG integration where material |
| Life insurer | 10-50 years | Long investment horizon recognition | Long-term; higher risk tolerance | ESG integration |
| Sovereign wealth fund | 30-150 years | Reputational risk | High tolerance for illiquidity and short-term underperformance | Some exclusions; engagement most important |
| Foundation / endowment | 50-250 years | Mission alignment; reputational risk | Long-term perspective permits higher risk tolerance | Exclusions to protect mission consistency |
| Individual / retail investor | 1-50 years | Personal ethics and values | Loss aversion | Screened funds; strong ESG integration |
Defined Benefit Pension Funds
For large institutional pension funds, the primary ESG driver is typically fiduciary duty. ESG factors are relevant to the extent they are material to investment returns and risk management over the relevant time horizon. These clients want genuine, deeply-integrated ESG, not a tick-box exercise, and they will challenge managers to demonstrate that ESG considerations actually influence investment decisions.
Foundations and Endowments
Charitable foundations often have a mission-alignment imperative that goes beyond pure financial materiality. An environmental charity cannot credibly hold significant oil company shares. A health charity might find tobacco holdings inconsistent with its stated purpose. Exclusions are often more prominent here, not necessarily because the excluded companies are poor investment prospects, but because holding them would be inconsistent with the institution's identity and mission.
Example, Foundation investment policy:
A foundation whose mission centres on public health and education might adopt an investment policy that: (1) excludes tobacco, gambling, and high-sugar food manufacturers from all equity portfolios; (2) requires ESG integration across all other asset classes; and (3) directs its stewardship programme specifically towards corporate transparency on health-related product impacts. These choices flow directly from the foundation's purpose rather than from a pure financial risk-return assessment.
Sovereign Wealth Funds
Sovereign wealth funds (SWFs) often operate with extraordinarily long time horizons and high tolerance for short-term volatility. Their ESG concerns tend to cluster around reputational risk, the political and social costs of being seen to hold assets inconsistent with the fund's public legitimacy. Engagement is often the preferred tool: with global diversified portfolios, outright exclusions can be difficult to implement at scale without significant tracking error costs.
Retail Investors
Retail investors are increasingly seeking investment products that align with their personal values. Unlike institutional clients, they are typically constrained to existing fund products rather than bespoke mandates. They are more likely to seek exclusions (no tobacco, no fossil fuels) and strong ESG integration, and they respond strongly to products with clear impact narratives, even if, for a sophisticated analyst, the underlying investment process is not significantly different from a non-ESG equivalent.
Whatever the client type, a core truth applies: the ESG approach needs to be genuine and consistent. Clients, whether billion-dollar pension funds or individual retail savers, are increasingly able to detect the difference between a firm with a deep ESG philosophy and one that has bolted an ESG team onto an unchanged investment process. A mandate design process that starts with authentic client beliefs and translates them faithfully into manager expectations is the foundation of a durable ESG investing relationship.
Key Takeaways
- 1ESG-aware mandates must cover four areas with enforceable specificity: monitoring ESG factors, investment integration rules, stewardship expectations, and reporting requirements - vague promises to consider ESG where relevant are impossible to enforce
- 2Hard constraint clauses (e.g., maintain 20% exposure to SBTi-validated targets) are binary and testable, giving clients a clear standard against which to hold managers accountable
- 3Investment consultants like Mercer, Willis Towers Watson, and Aon act as gatekeepers to the mandate pipeline - when they embed rigorous ESG questions into standard RFP templates, every manager seeking institutional business must engage seriously
- 4The PRI Due Diligence Questionnaire provides a standardised framework for ESG manager assessment at the RFP stage, reducing the risk that managers game bespoke questions
- 5Different client types arrive at ESG through different doors - pension funds through fiduciary duty, foundations through mission alignment, sovereign wealth funds through reputational risk, and retail investors through personal values
- 6Passive mandates are not ESG-free - the choice of benchmark (standard, ESG-tilted, CTB, or PAB), any exclusion overlays, and the stewardship and voting programme all create meaningful differentiation between passive managers