The ESG revolution results in a new suite of products that combine passive and active characteristics. Traditionally purely passive products are being tailored to meet specific ESG demands, for example on carbon emissions.
Passive investment today goes far beyond traditional pure index products. Gerben Lagerwaard, head of Benelux at State Street Global Advisors, has seen an acceleration in ESG integration in passive investment solutions in recent years. Investment Officer spoke about the development of ESG integration in passive investment solutions with Lagerwaard and his colleagues Jacqueline Lommen, pension strategist, and Philippe Roset, responsible for the ETF branch of the asset manager.
Boundary blurs
‘In our passive ESG customised solutions we see an increase in the number of exclusions, a bigger focus on reducing the carbon footprint and portfolios that need to be brought in line with the 2-degree scenario,’ says Lagerwaard.
Lagerwaard believes such developments blur the boundary between passive and active. ‘You can see tailor-made index solutions as a step towards active, because you deviate from traditional index investing with standard benchmarking,’ he says.
However, standard fund solutions such as ETFs do not go that far yet. So what value do
these instruments have for ESG-conscious investors? ‘As a rule, ETFs will not fully meet the individual objective of institutional investors, but they can add value to the tactical part of the portfolio from an ESG perspective,’ says Lagerwaard (pictured).
Self-indexing
Will institutional investors move in the direction of so-called self-indexing to meet their specific demand? Not necessarily, according to Lagerwaard. ‘The discussion is ongoing, but I do not yet see the traditional index providers are being abandoned.’
In his opinion, the strategic setting of a pension fund, for example, poses challenges as pension funds usually base their strategic allocation on a number of fixed benchmarks. ‘Pension funds therefore more often take a mixed approach, deciding for themselves what they find important, to then approach a traditional index provider to turn it into an index’.
Another reason why self-indexing appeals is the focus on costs. Roset believes index providers will ultimately follow the trend of lower costs rather than the trend of self-indexing. Costs remain of paramount importance because of the low-yield environment. Lommen agrees: ‘Because of their focus on costs, pension funds prefer passive investment solutions.’
Impact
But do passive investment solutions really lack the scope to integrate ESG objectives, since divestment is not an option if engagement fails?
Lagerwaard disputes the notion passive investors can have only limited impact because they cannot sell out of a stock. ‘If I look at the way in which we carry out engagement for our index investments, I think that is very impactful. We are providers of long-term capital and in that context we have also drawn up a structurally consistent engagement programme with 1- 3- and 5-year plans. We also show the concrete results in our annual reports,’ he says.
Recently, in an interview with the Financial Times, State Street CEO Cyrus Taraporevala also announced that he is actively using the voting policy to increase pressure on board members of large US, UK, Australian, Japanese, German and French companies whose ESG policies are lagging behind.