Asset Management

Active approach meets ESG challenges head-on

Sustainable Investing

Should investors looking for “sustainable stocks” go active or passive? Some market participants suggest the latter, proclaiming exchange-traded funds (ETFs) to be the future drivers of growth in sustainability investing. The problem with these passive, index-based vehicles is that they too often fail to distinguish between companies with the best ESG credentials and those that are just scraping by. Therefore, we believe an active approach is warranted.

Passive products turn ESG investing into a “computer says no” exercise, where money flows into companies that meet only the most rudimentary of index inclusion criteria, whereas clients expect much more from their investments.

Clients want to avoid investments in doubtful industries and sleep well at night. On the surface, exclusion-based indices support these goals, but deeper down there is a real problem, which endangers the trust of the client. Because clients understand that, their ultimate responsibility as capital owners in this arena is to induce change in the right direction.

Passive products do nothing to preferentially allocate money to firms running their business sustainably. Mr. Fink refers to clients in the Nordics, Netherlands and France as having sustainability as a requirement. Savvy investors who have such requirements will soon look closely and inquire why their money is invested equally in companies that are sustainability stars and those that just about meet minimum criteria. Clients expect the investment industry to support and drive change in the economy. This is why we need a much more thoughtful approach.

An active approach to ESG meets these challenges head-on:

Active analysis of companies ensures that money is allocated preferentially to firms with better business practices, to both avoid risks and reap the benefit of understanding companies’ positioning with respect to major issues such as climate change.

Active portfolio management ensures scrutiny and holding to account of company management. For example, active managers regularly meet with company leaders and often vote against them, in the interest of good governance and transparency.

Active portfolio managers are able to explain their actions and take considered decisions in borderline ESG cases. For instance, supporting companies that show the greatest willingness to change how they work, even if they are less “ESG” than others.

In addition, active managers are able to apply ESG principles across asset classes including emerging markets, fixed income, and real estate where a simple, index-driven approach simply does not work. Unlike passive products, active solutions can deliver what clients want across their whole portfolio.

And while in a “money-only” world passive and active approaches have their relative merits, a true ESG commitment asks for a clear conviction.

Avoiding a few bad apples and passively tracking an index will not contribute to solving the world’s most pressing sustainability issues. Clients expect more.