Why sustainable investors may rue being too passive
Why sustainable investors may rue being too passive
Growing social and environmental pressures are reshaping economies and industries before our very eyes.
This creates both risks and opportunities for investors whose portfolios need to reflect the changing world we live in.
Against this challenging backdrop, a forward-looking view of our fast-evolving world, rather than relying on past success drivers, will prove critical.
Yet the growth of passive funds over recent years is unlikely to align with this focus.
Passives now account for over one-quarter of global investments in sustainable funds. And while their momentum has clearly demonstrated the demand for low cost, easy access to global markets, investors in passive sustainable funds risk a mismatch between what they expect and the reality of what they receive.
For when it comes to traditional investment criteria, views of “large cap” or “high yield” are relatively consistent, meaning investors in passive strategies focusing on those characteristics have a good idea of the sorts of stocks those funds will hold. But sustainable investment is very different. There are stark inconsistencies between the company scores determined by different ESG rating firms, many of which are used to populate the indices of numerous passive ESG products.
This is clear even amongst the most widely-used and well-known scoring systems for company ESG measurement. Passive ESG strategies are therefore only as useful as the ratings on which they are based, which as our research demonstrates, vary considerably. Furthermore, many ratings are backward-looking and usually fail to predict controversies.
This is not surprising. For one thing, ESG analysis encompasses a huge range of topics and the importance attached to each can vary significantly. More importantly, sustainability performance cannot be captured by quantitative analysis alone, further underpinning the importance of an active investment approach.
Identifying a company's ESG characteristics requires fundamental, bottom-up, forward looking analysis, where views are unavoidably going to differ across firms.
For active managers, this creates opportunity. Active managers by their very nature will have a vested interest in the companies in which they invest: sustainable businesses underpin sustainable returns so by helping businesses become more sustainable is likely to benefit their overall portfolio and the returns for clients. Their extensive insight and knowledge into companies and industries is critical to meaningful and thoughtful discussions to help drive change, tackle challenges and ensure company management teams are held to account to make the transition.
There is no simple, single answer to achieving a sustainable future. It will require significant time and investment in helping local and global corporates make the change.
So, how can we accelerate this?
Rather than using screens to exclude vast swathes of the benchmark which we have shown to be based on significantly differing data, the key approach is to engage and influence as thoughtfully and comprehensively as possible. This ethos has been long established at Schroders and is an inseparable part of our investment process.
Most of our fund managers and analysts now have targets on high quality engagements. From this year, these are assessed and form part of fund manager appraisals and the results therefore affect their compensation. Over time, we expect the breadth and intensity of our engagements to continue to grow.
But engagement by itself is not enough. Measurement is critical to success. Any fund manager making a decision without first assessing the costs or benefits each company has for the environment and society is, to put it bluntly, flying blind.
The results of our latest Institutional Investor Study clearly show that clients are also keen to understand. We must strive to show how different company behaviours on issues such as taxation, healthcare and innovation can deliver social costs or benefits. We must also offer a granular view on carbon emissions on a company by company basis; and not just focus on the emissions accrued directly or through the firm’s value chain, but also consider the knock-on emissions created and rarely accounted for. There are other factors and nuances to consider in this debate. While it is true that large, passive managers have increased the sizes of their stewardship teams, a scaling up of thoughtful, critical analysis and diligence is far more difficult to replicate.
Clients 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 a clear-sighted judgement.
Over the long-term, the importance of an active approach to sustainable investment will only become increasingly obvious.
This article originally appeared in the Financial Times.
- Outlook 2023, China: will a loosening of zero-Covid provide a spark?
- Podcast: What the energy grid of the future might look like
- Economic and Strategy Viewpoint - Q4 2022
- China’s latest Covid crisis, war in Ukraine: observations for investors
- Outlook 2023, US multi-sector fixed income: yields up risk down
- Outlook 2023, Sustainability: five trends to watch
Important Information: This communication is marketing material. The views and opinions contained herein are those of the author(s) on this page, and may not necessarily represent views expressed or reflected in other Schroders communications, strategies or funds. This material is intended to be for information purposes only and is not intended as promotional material in any respect. The material is not intended as an offer or solicitation for the purchase or sale of any financial instrument. It is not intended to provide and should not be relied on for accounting, legal or tax advice, or investment recommendations. Reliance should not be placed on the views and information in this document when taking individual investment and/or strategic decisions. Past performance is not a reliable indicator of future results. The value of an investment can go down as well as up and is not guaranteed. All investments involve risks including the risk of possible loss of principal. Information herein is believed to be reliable but Schroders does not warrant its completeness or accuracy. Some information quoted was obtained from external sources we consider to be reliable. No responsibility can be accepted for errors of fact obtained from third parties, and this data may change with market conditions. This does not exclude any duty or liability that Schroders has to its customers under any regulatory system. Regions/ sectors shown for illustrative purposes only and should not be viewed as a recommendation to buy/sell. The opinions in this material include some forecasted views. We believe we are basing our expectations and beliefs on reasonable assumptions within the bounds of what we currently know. However, there is no guarantee than any forecasts or opinions will be realised. These views and opinions may change. The content is issued by Schroder Investment Management Limited, 1 London Wall Place, London EC2Y 5AU. Registered No. 1893220 England. Authorised and regulated by the Financial Conduct Authority.