Why sustainable investors may regret being too passive – Insurance Asset Management

Growing social and environmental pressures are reshaping economies and industries before our eyes.

This creates both risks and opportunities for investors whose portfolios must reflect the changing world in which we live.

In this challenging environment, a forward-looking view of our rapidly changing world, rather than relying on past success factors, will prove essential.

Yet the growth of passive funds in recent years is unlikely to align with this goal.

Liabilities now account for more than a quarter of global investments in sustainable funds. And while their momentum has clearly demonstrated the demand for easy, low-cost access to global markets, investors in passive sustainable funds risk a mismatch between what they expect and the reality of what they receive.

Indeed, when it comes to traditional investment criteria, views on “large cap” or “high yield” are relatively consistent, meaning that investors in passive strategies focused on these characteristics have a good idea of ​​the types of stocks these funds hold. But sustainable investing is very different. There are strong inconsistencies between company scores determined by different ESG rating agencies, many of which are used to populate the indices of many passive ESG products.

This is clear even among the most widely used and well-known rating systems for corporate ESG measurement. Passive ESG strategies are therefore only useful to the extent that the ratings they are based on, which our research shows vary widely. In addition, many evaluations are retrospective and generally do not predict controversies.

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It’s not surprising. For one thing, ESG analysis encompasses a wide range of topics and the importance given to each can vary significantly. More importantly, sustainability performance cannot be captured by quantitative analysis alone, which further reinforces the importance of an active investment approach.

Identifying a company’s ESG characteristics requires fundamental, bottom-up and forward-looking analysis, where views will inevitably differ from company to company.

For active managers, this creates opportunities. Active managers, by their very nature, will have a vested interest in the companies they invest in: sustainable companies underpin sustainable returns, so by helping companies become more sustainable they are likely to benefit their portfolio overall and returns to customers. Their insight and deep knowledge of businesses and industries are essential to meaningful and thoughtful discussions to help drive change, address challenges, and ensure that the company’s leadership teams are held accountable to perform. the transition.

There is no single, simple answer to achieving a sustainable future. It will take a lot of time and investment to help local and global businesses make the switch.

So how can we speed this up?

Rather than using screens to exclude large swathes of the benchmark that we have shown to be based on very different data, the key approach is to engage and influence in such a thoughtful and complete as possible. This philosophy has long been established at Schroders and is an integral part of our investment process.

Most of our fund managers and analysts now have high quality engagement targets. From this year, these are evaluated and are part of the evaluations of the fund managers and the results therefore affect their remuneration. Over time, we expect the scale and intensity of our engagements to continue to grow.

But commitment in itself is not enough. Measurement is critical to success. Any fund manager who makes a decision without first assessing the costs or benefits of each company to the environment and society is, to put it bluntly, blind.

The results of our latest study on institutional investors clearly show that clients are also eager to understand. We must strive to show how different behaviors of companies on issues such as taxation, health and innovation can lead to social costs or benefits. We also need to provide a granular view of carbon emissions company by company; and not only focus on emissions accrued directly or through the company’s value chain, but also consider induced emissions created and rarely accounted for. There are other factors and nuances to consider in this debate. While it is true that great passive managers have increased the size of their stewardship teams, an intensification of thoughtful and critical analysis and diligence is much harder to replicate.

Customers will make their own assessments. By asking each portfolio manager for clear examples of effective engagement and a clear view of the sustainability profile of their portfolios, they can make insightful judgements.

In the long term, the importance of an active approach to sustainable investing will only become more and more evident.

This article originally appeared in the Financial Times.

Michael J. Birnbaum