“All mutual funds become ETFs”, Detlef Glow, head of research at Lipper, wrote recently. Only passive and “real” active remain. Considering the inflow of over 500 billion dollars in the first six months into passive, that sounds plausible. But aren’t Lipper missing something? Passive and the hottest topic of the moment - ESG - do not go well together.
That was the impression Investment Officer got from a conversation with ESG specialist Ward Poirters and chief investment officer Kees Verbaas (photo) of Altis Investment Management.
There is no doubt about it: the rise of ETFs is impressive. 2021 promises to be an unprecedented record year. Halfway through, the counter already stands at over 500 billion dollars of inflow. According to Salim Ranji, global head of iShares & index investments at BlackRock, the growth potential for ETFs is unprecedented. “There are decades of growth ahead for ETFs,” he says.
So much smugness, however, calls for a critical review. Is it true what Salim Ranji says? Altis IM, which is part of NN Investment Partners and does the selection of managers and strategies for (external) fiduciary clients, is well placed to answer that. Last week, the company published a survey of over 60 asset managers with a total of 210 investment strategies, in which an ESG due diligence was carried out based on dozens of data points.
Difference between Europe and US
At the request of Investment Officer, Poirters, who analysed the questionnaires, shows how the examined strategies fit within the classification of the SFDR directive of the European Commission. In order for a product or strategy to be labelled as ‘light green’ or even ‘dark green’, i.e. complying with Article 8 or 9 of SFDR, Altis IM has extensively researched strategies in which its clients invest and has come to the following conclusions:
- Continental Europe: Article 9 (15 strategies); Article 8 (65 strategies); Article 6 (11 strategies)
- UK: Article 9 (0 strategies); Article 8 (10 strategies); Article 6 (22 strategies)
- United States: Article 9 (0 strategies); Article 8 (28 strategies); Article 6 (47 strategies)
- Others: Article 9 (0 strategies); Article 8 (0 strategies); Article 6 (12 strategies).
The results of the study make it clear that the differences between asset managers from continental Europe and the United States are significant. Many parties in the US do not have strategies that are considered to be at the level of Article 9, and at the level of Article 8, too, American parties lag well behind their European counterparts. If level 8 or 9 is not achieved, the level of article 6 remains, which means that there is an investment product that may not be promoted as ‘sustainable’.
Poirters and Verbaas explain the differences between American and European asset managers partly by the fact that the United States is much less advanced in enforcing a sustainable investment policy through legislation. Another factor is that the US mainly has large, globally operating asset managers that are strong in passive investment products, such as BlackRock, State Street Global Advisors, Northern Trust and Vanguard.
Many ETFs follow classic indices
Many Dutch pension funds still invest with these parties in index funds that replicate a classic, grey benchmark, such as the MSCI World Index or the MSCI All Countries Index. These products are usually classified by the managers as article 6 within the SFDR guideline. But those who hold these large, global indices pursue an engagement policy that in practice is a toothless tiger, argue Poiters and Verbaas: “Because engagement and voting have only limited effect if you, as a shareholder, cannot put your money where your mouth is and you have to keep the listed company in question in the portfolio simply because that company is included in the benchmark.”
Managers who replicate a classic, grey index have little or no room to implement a pronounced ESG policy. For a Best-in-Class approach or further ESG integration, the transition to green benchmarks can be a solution. With the advent of the so-called Paris Aligned benchmarks (PA), this possibility is in sight and an increasing number of Dutch institutional investors are showing interest. However, Altis IM points out that the number of providers is still limited and the invested assets in these PA-indices are still relatively small.
Little exposure to Paris Aligned benchmarks
Verbaas, who maintains many contacts with pension funds and other institutional parties, argues that the discussion about ESG criteria and “grey trackers” has now gained momentum. At the same time, pension funds are still lagging behind in this respect and generally prefer index funds and trackers in the core of the portfolio. This is also because these PA benchmarks are still a relatively new phenomenon.
But Verbaas thinks that under the influence of developments in society and legislation and regulations, this could now start to change. He and his colleague Poirters think that this discussion can be accelerated if Brussels tightens the SFDR guideline and the classification of the level of products. For example, the SFDR directive will be followed up in the course of next year. Then asset managers will have to explain how they take into account the significant negative effects that the companies in which they invest have on sustainability factors.
Against this backdrop, Verbaas and Poirters see a number of important challenges in the coming years, specifically for providers of ETFs and other index products now that asset owners are increasingly discussing financial returns versus social returns.
“We see the risk budget being used more and more to achieve ESG goals rather than to achieve a better return than the market average. What if you invest in ETFs, which have a “lagging” index as a benchmark? Pursuing a very specific ESG policy is at odds with tracking a (grey) index as well as possible. I think that in the boardrooms of index product providers, the main topic of discussion is how to respond to the ESG trend with new index products”, concludes Verbaas.