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How Green are Recycled Funds?

Asset managers are increasingly re-labelling existing products as sustainable, but there are few rules and plenty of pitfalls.

As a society, we are becoming accustomed to the idea that it’s often better to recycle or repurpose than to start again from scratch. For asset managers, this is increasingly true of existing funds that don’t have underlying sustainable strategies.

“Asset managers have always been reviewing and tweaking their funds – that’s nothing new – but as ESG expands across all markets, tweaking is happening with sustainability in mind,” says Hortense Bioy, Global Director of Sustainability Research at research provider Morningstar.

Asset managers decide to re-label existing funds as green investment vehicles for two reasons, according to Paul Lacroix, Head of Structuring at Smart Beta specialist investment firm Ossiam, an affiliate of Natixis.

“The first is client demand for investment solutions that are ESG-based,” he tells ESG Investor. “The second driver is the desire to participate in the climate transition.”

A third reason, highlighted by a recent report by Morningstar, is that it’s more cost-effective to rebadge existing funds with assets already under management than to build something new. In particular, it’s a useful method for reinvigorating funds that have been struggling to attract new flows, the report said.

In 2021, 536 funds across Europe were repurposed as sustainable, double the number re-labelled the previous year, according to Morningstar. This includes Aberdeen Standard’s European Sustainable and Responsible Equity fund and the Vanguard SustainableLife 60-70% Equity fund.

In Europe, the Sustainable Finance Disclosure Regulation (SFDR) has had a huge influence on the kinds of funds asset managers are developing and how they are then marketed, the report noted.

But funds outside of Europe are also being rebadged. For example, the freshly labelled US-based AB Sustainable Global Thematic fund (formerly the AB Global Thematic Growth fund), which has US$153 million in assets and now targets companies aligned with the United Nations Sustainable Development Goals (SDGs).

The process isn’t always plain sailing, especially for passive funds, with asset managers citing difficulties identifying the appropriate sustainable indexes to replicate. Further, a lack of transparency around why a fund has been re-labelled as sustainable and the impact the new label has on the fund’s environmental-related characteristics or performance can ignite greenwashing concerns.

Asset owners have told ESG Investor they will continue to closely scrutinise funds with new sustainable labels.

“Labelling a fund as sustainable isn’t enough for us, and we will look at the details to ensure the strategy is genuine and demonstrating real-world impact,” says Adam Matthews, Chief Responsible Investment Officer for the Church of England Pensions Board.

Patrick O’Hara, Director of Responsible Investment and Engagement at UK-based LGPS Central, agrees, noting that all institutional investors should “search under the bonnet” and “challenge the fundamentals more deeply”.

Writing out the label

Changing the ethos and orientation of a fund isn’t as simple as merely changing the name, of course.

For active funds, there is typically an “extensive research” process to identify if re-labelling is in the best interests of clients and whether it makes commercial sense in the existing market, according to Cathrine De Coninck-Lopez, Global Head of ESG at Invesco.

“It also involves changing the fund investment process to both ring-fence or delimit the investment universe and actively select holdings according to ESG characteristics. Our global ESG team has to sign off on ESG products, along with oversight functions such as legal and compliance. Depending on the jurisdiction, such a process would typically require regulatory notification and shareholder notification and/or approval,” says De Coninck-Lopez.

Invesco recently launched the rebadged its Invesco Sustainable UK Companies fund. While the overall objective hasn’t changed, each holding in the portfolio is now individually assessed using a revised sustainable framework based on “proprietary screening and analysis of what is believed to be best-in-class available ESG data”, she says. This due diligence process sits alongside traditional financial and strategic investment analysis, valuations, and risk monitoring.

When re-labelling passive funds, asset managers must find suitable alternative indexes to track.

BNP Paribas Asset Management (BNPP AM) announced in December 2021 its intention to integrate ESG criteria across its entire passive fund range by the end of this year, tracking broad ESG and Paris-aligned benchmarks.

Following this commitment, 83% of the firm’s exchange-traded fund (ETF) product range is classified as an Article 8 or 9 fund under SFDR.

The first strategy Ossiam switched to sustainable was the Ossiam Minimum Variance strategy in 2016, says Lacroix. “Since then, we have switched a number of our ETFs to start tracking ESG indices or active ETF strategies with an ESG and/or low-carbon approach,” he notes.

Most recently, Ossiam’s rebadged STOXX Europe 600 ESG Equal Weights UCITS ETF was switched from tracking the STOXX Europe 600 Broad Market Equal Weight index to the STOXX Europe 600 ESG Broad Market Equal Weight index earlier this year. It carries 80% of the securities of the parent index, with a 0.2% weighting per holding. By further applying an ESG screen, companies not compliant with Sustainalytics Global Standards Screening, involved in controversial weapons or without ESG scores are excluded from the fund.

While Ossiam wanted to ensure the index employed the right filters, the firm also “wanted [the ETF] to generate the same kind of returns as the original strategy and maintain the DNA of the original fund”, Lacroix notes. “It’s ultimately a balance between how much ESG you can incorporate versus the financial profile of the old strategy.

Rebadged sustainable passive funds commonly include “climate-related targets being tied to investment strategies”, Morningstar’s Bioy says.

For example, switching the BNPP AM’s MSCI SRI S-Series 5% Capped ETF range resulted in an initial 50% reduction in carbon intensity across the seven indices. This will be followed by an annual decrease of 7% to stay on track with limiting global warming to 1.5°C.

Complying with SFDR

With Europe’s SFDR regulation only partly in force, asset owners are already favouring Article 8 or 9-labelled funds, prompting asset managers to rebadge existing strategies to meet demand.

Assets in Article 8 and 9 funds reached €4.05 trillion by the end of December 2021, according to a Morningstar report – the equivalent of 42.4% of all funds sold in the EU.

Despite the European Commission’s efforts to clarify requirements for funds to be classified as Article 8, experts have criticised its wide scope, noting that funds with exclusion strategies are included alongside much more proactive sustainability-focused investment products.

Due to the wide spectrum, BNPP AM has decided to “internally define” Article 8, says Isabelle Richard-Bourcier, Head of Quantitative and Index Management at BNPP AM. “We don’t think excluding sin stocks is enough for a fund to qualify as Article 8; these funds should go deeper,” she says.

SFDR Level 2 will introduce regulatory technical standards (RTSs) under which asset managers must justify their Article 8 and 9 categorisations through environmental and social principal adverse impact (PAI) disclosures.

However, SFDR Level 2 has again been delayed due to the European Supervisory Authorities (ESAs) introducing additional RTSs for consideration, which will ask asset managers to disclose their funds’ level of alignment with the EU Taxonomy Regulation’s list of environmental activities.

The current situation means that asset owners may not be able to get hold of the granular details to scrutinise and compare funds, including those relabelled expressly to meet SFDR’s rules.

“But that shouldn’t prevent asset managers from providing more detail now,” says Bioy, particularly in cases where funds have been re-labelled to meet SFDR requirements. Even if all the necessary data isn’t available to provide in-depth disclosures, asset managers should “at least outline how they plan to account for ESG-related issues in their investment strategies”, she adds.

When the shoe doesn’t quite fit

Existing ESG and sustainability indexes aren’t always the right fit for a re-labelled passive fund.

“We are seeing more institutional clients asking for customised sustainable solutions,” says Etienne Vincent, Head of Quant Strategy and Marketing at Ossiam. More tailored demands mean that asset managers with passive funds are also having to create equally tailored indexes.

Index providers, such as Qontigo and Foxberry, allow asset managers to create custom-built indices, allowing them to tailor indexes to best support their new sustainable strategies.

This is presenting a potential problem for traditional index majors, such as MSCI and FTSE Russell, as asset managers increasingly turn to self-indexing as opposed to tracking existing sustainable and ESG indexes. For example, Legal and General Investment Management (LGIM) previously noted that a number of index providers either couldn’t or wouldn’t help the firm create customised ESG indexes for their funds.

BlackRock, the world’s largest asset manager, purchased index provider Aperio in 2020 for US$1.05 billion so it could customise existing equity indexes to meet client needs.

Once a passive fund is tracking a new index – tailored or otherwise – measuring the impact of the changes to a fund’s strategy can be easier compared to an active fund, as the former is “tracking an index with specific rules”, says Bioy.

“It can be trickier for an investor to understand the impact of new ESG considerations on an active portfolio, because securities can be bought and sold for other reasons beyond ESG factors,” she says.

Avoiding greenwashing

Changing a fund’s name and strategy without being fully transparent as to why, when and how can lead to asset managers becoming subject to greenwashing accusations.

“If there’s no available information about the sustainable strategy online or within the fund documents, then that makes us question whether the changes made are actually significant,” Bioy says.

Further, there are instances where asset managers may change the underlying ESG constraints or sustainable investment strategy without changing the fund’s label, which can make tracking and analysing their impact difficult.

“We continue to struggle to find the effective dates at which funds repurpose prospectuses, fact sheets, and key investor information documents rarely indicate when the changes take place,” Morningstar noted in a report.

Whether labelled as green or not, greenwashing by investee companies can have a knock-on impact on the sustainability performance of funds.

Recent research by think tank Planet Tracker warned that a number of companies, such as fashion corporates, use ‘zombie data’ – false, unverifiable or lacking credibility – to meet environmental disclosure requirements. Unless asset managers closely scrutinise the information provided by the companies they invest in, they may further perpetuate greenwashing by including companies in their re-labelled sustainable funds that don’t meet the terms of their updated policy.

Engagement by fund providers is key to managing corporate greenwashing, says BNPP AM’s Richard-Bourcier.

The asset manager works with its Sustainability Centre team, which uses its own ESG scoring methodology to “conduct due diligence and ensure investee companies aren’t greenwashing”, she says.

Asset managers demonstrating best practice should be able to show how investee companies’ sustainability-related performance is a “reflection of [their in-house] ESG integration process and stewardship activities”, says O’Hara.

Ultimately, however, a fundamental step toward mitigating greenwashing and reassuring asset owner clients is “ensuring that products do what they say on the tin,” says Invesco’s De Coninck-Lopez. “[Asset managers] can demonstrate that they have fulfilled a product’s stated objectives through enhanced reporting.”

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