Active Funds not Necessarily Superior to Passive for ESG Investors

Specialised and generalised engagement seen as effective agents of change.

Both passive and active funds can contribute to ESG-focused investment strategies if their managers play to the natural strengths of those vehicles, according to a panel of experts in sustainable investments.

“I’d like to move away from the idea that engagement is always good and capital allocation is always less powerful,” said Alex Edmans, Professor of Finance at the London Business School and Academic Director of the Centre for Corporate Governance, speaking at a webinar hosted yesterday by funds processing network Calastone, titled ‘Entering the ethical investment revolution: preparing for societal upheaval’.

“It’s important for investors recognise that it’s not their job to solve all the problems of every company, but to focus on the type of engagement in which they have most expertise,” added Edmans. “A passive fund is spread too thinly to get into the weeds of any individual company’s strategy, so specialised engagement won’t work for them, but generalised engagement – voting policies aimed at moving toward more independent boards – is something they can do.”

Edmans cited activist hedge fund ValueAct Capital Management’s role in encouraging Adobe to move to move its revenue model from selling software to licensing on subscription as an example of successful specialised engagement.

Although ESG investing has been regarded as an opportunity for differentiation for actively-managed funds, 2020 has seen significant inflows into ESG-themed exchange-traded funds (ETFs) and products (ETPs). Strong net inflows during the first half of the year meant the total assets of ESG-focused ETFs and ETPs reached US$100 billion in July, according to specialist consultancy ETFGI.  Total assets invested in ESG ETFs and ETPs increased by 14.7% from US$88 billion at the end of June 2020.

Globally, ESG funds saw inflows of more than US$70 billion in Q2 2020, according to Morningstar, driving total assets under management to a record level of US$1 trillion.

Panellists at the Calastone webinar noted the appeal of low-cost vehicles, such as ETFs, to retail investors. “As we see a continued rise in interest in ESG from retail investors, particularly young ones, a lot of those solutions will be passive,” said Stephanie Lipman, ESG Analyst, La Française Asset Management.

Leon Kamhi, Head of Responsibility at Federated Hermes, argued that stewardship should be considered an important part of the role of the active manager, outlining an increasingly interactive  relationship between investor and issuer: “Be a supporter and encourager of boards to do the right thing by their stakeholders, which leads to their company being more sustainable,” he said. “This covers strategy, capital allocation, even investor relations, anything that aligns the company more to the investors’ interests.”

Commenting on the question of whether it is better for funds to disinvest in a firm which does not adequately address its ESG risks or to continue to work constructively to win management round, Edmans said specific circumstances should dictate action.

“People often argue that an investor that sells out of a stock is being short term. There is praise of patient capital and loyal shareholders. But that can be dangerous. It depends on what causes you to sell.” Edmans said.

“If you sell because a firm has missed its quarterly earnings target, that’s not good, But you might sell, even if the stock is delivering high long-term earnings, if you don’t believe it’s investing enough in the future. If engagement isn’t working, perhaps because of management intransigence, to sell is a legitimate course of action.”


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