Funds Europe – Without playing a part in shareholder voting, can ETFs ever really play a material role in ESG investing? If so, how?
Mahmood – When we talk about passive instruments, this doesn’t mean passive on engagement. Most providers’ websites show vast quantities of voting records, some more detailed than others.
Contrary to some assertions, we find that ETF managers are typically highly engaged when it comes to their corporate governance and stewardship. ETF managers are long-term holders of securities, for whom liquidating positions is not a realistic option. This means they have a seat at the table when it comes to company engagement, every year.
In fact, it’s often forgotten that many of the world’s largest ETF issuers also have significant active management businesses. This allows them to leverage significant governance resources, at low costs. On the topic of ESG, it isn’t just about voting, it’s about materiality too. What is financially material from an environmental, social and governance point of view down the line for these companies?
Garcia-Zarate – The fundamental issue here for passive fund providers is that obviously they cannot divest, so the engagement aspect of the corporate governance is essential. They have to engage for the long term, because basically this is like a long-term marriage with no possibility of divorce, unless the index decides to drop a company. The relationship with a passive fund provider is very different because you are there for the long term and this is something that needs to be better explained.
Baron – The beauty with ETFs is their transparency. Investors can choose a specific product and vote with their money by deciding not to allocate to a specific ETF if it is not aligned with their values. We believe that as European regulators increasingly seek demonstrable evidence of ESG integration, investor demand for sustainable investments is set to continue its strong growth trajectory. Flows into sustainable ETFs more than doubled in 2019 and we believe this momentum is likely to continue, supported by the new benchmarks and robust disclosure regulations. It is up to investors to decide where their money goes and through ETFs, they can see exactly what they own.
Guthrie – You’re never going to put a product out that ticks the ESG criteria for everyone. You might want to do something hyper-restrictive, but then you’ll miss a portion of the market that somebody wanted to be in, because you’ll lose 50% of your index if you do it on the most adverse selection.
Clients are going to want an investment company whose principled approach to markets lines up with theirs.
Are people going to take one ESG product from a provider when the management fee that they’re being paid enables them to offer a whole range of non-ESG-compliant products to other investors? They’d essentially be facilitating that firm to propagate investment in these non-ESG companies.
I do think that this could end up at a level that is firm-wide. This talks about voting, stewardship, this talks about their approach across their product set, are they willing to take some tracking error to exclude a handful of stocks from an index tracker? I think this is the direction that people who really want to vote with their money will take.
Garcia-Zarate – The fundamental challenge for the passive providers is what are they going to do with the companies or issuers of bonds that do not meet their ESG criteria? Are you just going to say, ‘Sorry, I can’t do anything because they are in the benchmark,’ or will you say to investors, ‘We are going to accept higher tracking error in order to comply or meet your ESG expectations.’ That’s an interesting discussion for passive fund providers and investors to have, because a lot of people are quite willing to accept the trade-off, and other people are not. One thing is talking, and the other is accepting that you might lose out for the sake of your convictions.
Guignard – Again, one of the advantages of ETFs here is their transparency. ESG ETFs can provide that level of transparency to investors. This allows investors to have a very precise idea of what they are investing in and exposed to. When selecting an ESG ETF, one of the very first steps for investors is to choose a manager who has a robust engagement and voting strategy.
As long as you are a shareholder of a company, you can have dialogue with that company. In the end, the behaviour of that company will be reflected in its ESG scoring, so it will also have an impact years after, either in the weight of that company in ESG indices, or it may be excluded at some point if the rating is too low.
Mahmood – Investors will increasingly want to see the results of engagement. It’s all good having years of meetings, but what’s the outcome? Something some providers are increasingly doing is providing information on engagements and what the outcome is. It’s ultimately negative PR for some of these companies if they fail to follow through. This is one way of adding pressure: by publicising the entire engagement for everyone to see, to understand what the issues are and where they’ve misbehaved.
An area that still requires some work is knowing one’s true ESG position. Firms tend to have a vague idea about what they believe in – however, there’s a role to play in providing guidance. There are a lot of sustainable portfolios out there where the equity fund may have excluded, for instance, Apple – because of privacy issues. However, when you look at the fixed income fund and there’s an Apple issue in there, there’s inconsistency in people’s views and what they believe.
Shah – ETF investors are not activist investors, but they are certainly one of the top investors at a fund level, so they should have that representation on behalf of the underlying holders. While the ETFs are fully transparent and the investors know what they are actually getting into, it might take a while to broaden that horizon for the investors and to also tap into the market.
Next, I think while ESG is important and growing, there is a lot more awareness in Europe and the US still has a lot to catch up on. The industry needs to work a lot more closely with the index providers to create specific ESG-related indexes, and then provide the ETFs around it which will then take care of the needs, whether it’s on gender equality or whether it’s environmental aspects or social aspects.