How significant is the shift in attitudes of pension funds towards passive investments generally? What do you think they have come to realise about passive funds?
The survey of pension funds managers we had CREATE-Research carry out shows clearly that passive investing has become mainstream among pension funds. The survey questioned 150 pension fund managers globally, who collectively manage €2.9trn in assets. It found that 66% of respondents view passive solutions as a mature part of their portfolio, with passives being implemented via traditional indexed funds, segregated accounts or ETFs.
The survey found that passive investments are viewed as having four intrinsic positive characteristics. First, most of the pension funds surveyed view passive investments as providing a low-cost option in a low-return environment. Second, almost half of the pension funds surveyed saw passive solutions as enhancing their plan's core-satellite approach to asset allocation, providing a clear separation between alpha and beta and their fee structures. A large number of pension funds also see passive investments as providing for a balanced portfolio alongside active investments. Finally, a lot of pension funds see passive solutions as an ideal vehicle for global asset diversification.
What significance do you think this shift will have on the asset management world?
It's definitely the case that more money will continue to flow into passive investments in coming years. In some areas, like the market for bond ETFs, we're just scratching the surface in terms of the potential to gather significant assets under management. The shift does not mean that active asset management no longer has a place. It definitely does, and our survey shows that, but there is no doubt that asset managers need to be offering passive solutions at the same time, and increasingly hybrid solutions bringing together active and passive and alternatives.
Do you think anything can alter this move? Is it in any way reversible?
Forty-two percent of the pension funds surveyed believe passives will become a permanent feature of their investment portfolios. And if and when markets reverse, the swing away from passives will be moderate, with only 35% of respondents believing that any such swing will be much bigger, although not to the point of reversing all the gains in market share achieved over the last decade. So it seems clear that passive investing is definitely here to stay. It is the case that some of the underlying trends that have favoured index investing over the last 10 years, like quantitative easing pushing up the prices of risky assets, will change - indeed we're see QE programmes reducing now. But the overall trend is clear. The move towards low-cost passive investing will not reverse.
Conversely, do you think the shift will accelerate in the years ahead and what trends will provide a further impetus?
There's definitely room for more growth in passive investing in years to come. The European retail market for example is still way behind the US in its use of ETFs. The uptake of fixed income ETFs as that market attracts more liquidity will also be a driver of growth. In the pensions market the survey we commissioned found that on an asset-weighted basis the total passive portfolio held by surveyed pension plans is likely to grow over the rest of this decade at an annual rate of around 6%. The survey also found that passives are moving into the buy-and-hold portfolios of pension plans. Interestingly, we also found that nearly half of the pension funds surveyed view the rise of risk factor investing facilitated by new technology as a passive investment growth driver, and that ESG and other emerging themes favouring low-cost solutions are a driver.
Shifting slightly, the survey also provided evidence of the shift towards ESG investment; what do you think lies behind this and is it consumer/investor-driven?
In the wake of the COP21 Paris Climate Conference, markets have finally started to price in climate risk in earnest. In turn, pension plans have responded by putting this risk at the heart of their sustainable investing and stewardship goals. ESG investing is likely therefore to be led by institutional investors. Forty-one percent of respondents to the pension survey we sponsored regard passives as a low-cost avenue to pursuing ESG and other themes. After all, their commitments to their plan members are long-term. Their delivery requires a sustainable economy and society. That means finding long-term drivers of value that override the regular volatility spikes. Four factors are enhancing the appeal of themed funds for pension plans. First, they help focus attention on investment risks that are hard to model because they have only recently been treated seriously, like climate change. Second, in the age of social media themed funds also help to manage reputation risk, which has raced up the agenda of pension plans. Third, implied risks also offer opportunities, as they are increasingly priced in by markets. Finally, there has been a lot of innovation around ESG-based smart beta strategies that slice and dice the ESG universe to suit investor needs. ESG screens are used especially when investing in emerging markets, where governance practices differ markedly between and within countries. We've implemented a number of ESG mandates for pension funds over the last two years. We provide a full-service capability for integrating ESG factors into passive equity and fixed income portfolios, backed by research from a dedicated ESG team headed by a chief investment officer for responsible investments. We create customised ESG overlays implemented at the benchmark or portfolio level, and also products and solutions that track standardised ESG indices - our ESG Xtrackers ETFs of course provide intra-day liquidity, which is attractive for those with a very high liquidity preference. We also provides in-depth index advisory.
What effect do you imagine this demand will have on the supply of ESG passive products?
There will definitely be continued increased demand for ESG passive products. In May we launched four new Xtrackers ESG ETFs to help meet the increased demand. The new ETFs provide exposure to ESG-filtered equity indices tracking global, US, Japanese and European markets, and the underlying indices are part of the MSCI ESG Leaders Low Carbon ex-Tobacco Involvement 5% series. These use extensive filtering based on MSCI ESG research, which means included companies meet strict ESG and low carbon requirements.
With smart beta, what do you think lies behind the enthusiasm for smart beta and other forms of thematic investing? Is this also consumer-led? Or is this more supplier led?
The trend towards smart beta, and particularly factor investing, is being driven by sophisticated institutional investors. This is partly because it can offer an attractive half-way house between active and passive. Factor-based investing can also offer other benefits however. When the financial crisis hit a lot of investors who thought they had diversified portfolios because they were diversified in the traditional way across asset classes and geography suddenly found that the assets they were holding were highly correlated. Factor investing lets investors build portfolios in a truly diversified way. Like ESG and thematic investing, smart beta is definitely here to stay.