Industry Updates

Inside ETFs 2018: ESG investing in focus

Scott Longley

The investment world still takes a "schizophrenic" attitude to ESG investment in ETFs believing there must be underperformance despite the evidence to the contrary, according to an expert panel at Inside ETFs yesterday.

Aniket Shah, head of sustainable investing at Oppenheimer Funds, pointed out that there was evidence from the main ESG tracking indices that working within environmental, social responsibility and governance guidelines doesn't detract from corporate performance but can improve it.

But he added that the fact that people still believed it would be a negative for fund performance was telling. "The premise for the questioning is very strong," he said. "Many still believe ESG will lead to underperformance, despite the evidence. There has been movement (in recent years) for sure, but we haven't been able to square the circle."

Statistics show an explosion of ESG packaged product on the last two years. Sarah Lee Kjellberg, director and head of US iShares sustainable ETFs at BlackRock, said the sector had been "sleepy" up until late 2016 and suggested there might be a correlation with the election of Donald Trump as President.

"When Trump pulled out of the Paris climate agreement, many companies doubled down on their environmental commitments," she said by way of illustration.

Shah added that it was on climate change where the net effect of ESG investing was most under scrutiny. "That's the big risk," he said. "Stranded asset risk. Over the short term the timing issue is very important. There might be under-performance in the short term, but government actions in the long term could change that."

Richard Cea, executive director of exchange traded products at UBS, said that the enthusiasm about ESG funds right now was partly down to a demographic shift but it was also a reflection of wider business and investment concerns.

"Millennials are very aware. But I think there is a bigger thing going on. Investing not different to everything else. Align your portfolio to your values. It has to make a difference."

Cea suggested that thematic ESG funds are one route to tapping into the enthusiasm for 'doing good' with an investment portfolio, but Shah was sceptical of this approach and suggested that ESG should properly be viewed across any individual's entire investment portfolio.

"ESG is just good investing," he said. "It is thinking about issues that all investors should be thinking about. You really want (ESG) to be as big a pool of your investments as possible.

"I'm not sure about thematics. It minimises it and makes for a very small group of potential companies. I'm more excited about ESG integration for larger companies. That makes a lot of sense."

Kjellberg said that product segmentation in this space is critical, adding that BlackRock defined it according the three strategies of prevent, promote and target.

The first is about screens. BlackRock works with clients that have very explicit values. "Ex-fossil fuel is coming up a lot," she said.

Then under promote, the company looks at the integration of ESG generally, tilting a portfolio towards companies that rate higher in ESG. Lastly, the target strategy is about thematics and impact.

"What ESG is trying to do is measure risk and opportunities which aren't covered in other investments," she said. "It brings to the surface a different lens, and how they think and operate."

The thorny issue of passive engagement in corporate oversight was also touched upon. In the middle of this month, BlackRock's Larry Fink sent a letter to the chief executives in the US encouraging them to consider societal implications of their business decisions.

Kjellberg suggested Fink's letter represented a "meaningful shift". "He is saying it's not just about profit at any cost," she said.

Shah said it was "definitely welcome progress". "Larry Fink deserves credit," he added. "It's very easy to get very excited about the ESG progress. As investors, it is important to identify area where things are getting better and where it isn't."

On climate change, he added, "things are getting worse." "Renewable energy spending has plateaued and we are not even close to breaking the back of that problem," he said.

"We need to distinguish what's getting better and what's getting worse so that through proxy voting, investors can focus on areas where they can make a difference. It's important that passive investors get involved in that."

He added that the current interest in ESG was largely institution driven. "Many companies have stepped up and are saying they are looking at this as part of their fiduciary role. The movement will be more difficult in the US compared to Europe. There you have a group of people looking at 50-100 year risk, institutionally in Europe."

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