It is very difficult to apply ESG criteria consistently to purely passive investments. Active investments lend themselves much better to this. It is easier to apply an integration approach that goes beyond exclusions in active management. In the end, it is all about the client’s profile, which has to match the risk/reward profile of a fund or strategy and the client’s sustainability preferences.
This emerged from an interview with Michaela Zhirova (pictured), head of ESG products and research at Nordea AM. “It has to fit the profile of the client, whose needs vary according to the profile. Our approach is not primarily based on exclusions. That is a tool that, in my opinion, has many limitations. We are more interested in ESG integration. As a sustainable investor, we have built up a long track record in that area, which gives us a big advantage over other players. On the one hand, it is positive that the bar is being raised in the sector, but on the other hand, clients also need more expertise to see the wood for the trees in a landscape of different labels and expanding regulations.”
ESG characteristics
Nordea AM has a limited number of Article 9 funds in its range and many Article 8 funds. Zhirova clarifies that this is not the whole range: “We also have a certain number of Article 6 funds. Our ambition is to have a minimum ESG overlay across the board. There is a strong interaction between the Responsible Investment Committee and management. For certain funds, portfolio eligibility thresholds are based on internal scores set by the Responsible Investment team. Incidentally, most fresh money flows into funds with ESG characteristics.”
MiFID
Zhirova cited a change in MiFID regulations that is important for sustainable investors. “Article 8 and 9 are ultimately disclosure standards and they are not about changing investors’ behaviour. So they are certainly not sustainability standards in themselves. This has been made clear by the latest amendment to MiFID, which requires products to indicate what percentage they invest in sustainable investments. It is theoretically conceivable that some Article 9 products will therefore have a lower percentage of SRI than some Article 8 products.”
According to the specialist, there are no specific thresholds yet that determine how much SRI a product must contain under a certain category. What is a credible threshold? Will a customer buy an Article 9 product with 60 per cent SRI, or higher? This clarification is a must and this debate will ultimately be more important than just whether products fall under Article 8 or 9. Therefore, before setting targets, we need to better define what is sustainable.”
Tariq
The discussion also covered a recent interview with whistleblower Tariq Fancy, who used to work on SRI at BlackRock, and who was particularly critical of SRI in a recent interview in the Financial Times. “I respect whistleblowers. They stir up debate and remind us that we can jeopardise our credibility with meaningless marketing talk. It pays to speak openly about our challenges, because SRI is no easy task.”
However, the specialist also offered a caveat, saying that Tariq Fancy’s perspective is to some extent shaped by the context in which he has worked, particularly entirely passive investing.
As a passive investor, it is much harder to apply sustainability criteria in a meaningful way than as an active manager. As an active manager, you can accept that performance fluctuates more. As a passive investor, you are limited by the tracking error that you have to respect.
She cited the example of the fossil fuel sector. “That is clearly not a sustainable sector, so an underweight position in a sustainable financial product would be justified. In an actively managed fund, you can take and justify that position more easily. However, if your product has to shadow the index, that is already a lot more difficult. Therefore, deep ESG integration is usually easier to achieve in an actively managed fund.”