Is a passive fund management approach accordant with environmental, social and governance (ESG) investing? The growth of both these trends has led to the question as to whether they are happy bedfellows.
The growth in ESG indices supporting passive strategies and the recent launch of a number of ESG passive funds, places it as an increasingly popular and credible alternative to an active approach. In the first six months of 2021, “of 80 exchange-traded funds and mutual fund launches in the UK, 37 were ESG vehicles.” 1
There is a popular opinion that only through active fund management can effective ESG change be achieved. Through positive inclusion, companies with high ESG credentials built into sustainable portfolios are helping investors to sleep better at night.
Although active management facilitates positive inclusion and quick responses to controversy, such as with Boohoo in 2020, it does raise a slightly different question. Does stock picking ‘sustainable’ funds drive broader and deeper change?
Setting the passive vs active cost argument to one side, by looking at an index linked passive strategy, it is clear that a greater number of companies will be engaged by fund managers and their ESG concerns, potentially driving wider and arguably greater change.
At EBI, we have circa 7,000 equities in its Earth portfolios, avoiding the concentration of a few hundred stocks that most would expect to see in an ESG portfolio. 2
Funds within EBI ‘Earth’ portfolio follow different ESG methodology which broadly fall into three approaches; exclusion policies which removes companies in ‘dirty’ sectors such as those involved in vice industries (tobacco, gambling) or controversial weapons, funds which employ carbon reduction strategies and finally fund managers which have strong engagement or stewardship policies. All within the context of index or rules based fund providers.
Stewardship, often overlooked, is “the responsible allocation, management and oversight of capital to create long term value for clients and beneficiaries leading to sustainable benefits for the economy, the environment and society.”3 . This includes executive compensation, shareholder rights and importantly proxy voting.
Vanguard 4, reported in its 2020 Investment Stewardship Annual Report that they voted on $1.917bn index assets in 2020, which is c. 55% of total index equity assets.
At a high level, this includes:
- Votes on 168,305 proposals at 18,476 company meetings.
- 27 markets engaged.
- Discussed compensation in 70% of our engagements.
- Engaged with 258 companies in carbon intensive industries, or 33% of all companies engaged.
- Met with independent directors in 46% of our engagements.
- Voted against 384 directors because of executive compensation concerns.
In Northern Trust’s Stewardship Report 2020, the investment manager voted on 148,039 resolutions at 15,681 meetings, voting 13,728 times against management. 5
Likewise GSI and Arabesque fulfil their stewardship obligations on behalf of investors.
The figures above demonstrate the breadth and depth of engagement, and how sustainability is being prioritized in boardrooms across the world.
The recent growth in ESG investing, accelerated in part by the current pandemic, has shifted ESG from a niche to a fundamental strategy and is a“ “transformative and irreversible” trend according to Georg Kell, Chairman of Arabesque. 6
The rapid growth of ESG raised the question of whether ‘ESG is another bubble waiting to happen?’, on the EBI members forum. EBI Non-Executive Director Sam Adams makes a useful point in that because there is no broad consensus on which stocks are ESG, the investment in ESG is flowing into a broader range of companies, negating the bubble thesis.
John Dewi 1 counters the bubble argument with the point that “there is still a shortfall of capital to many areas that are crucial to the transition to a sustainable economy.”
Improvements in “creating well established ESG indices” 7 to help better demonstrate returns for investors are required, but in adopting a passive approach, investors are not only taking advantage of the cost advantages but also engaging companies for future change on a much wider level.
EBI are currently running a series of ESG webinars titled the ‘Summer of Sustainability’ with industry experts Sam Adams, Garrett Quigley, and Julia Kochetygova.
 J Dewi, Is there really an ESG bubble?
 EBI blog – ESG – Another bubble waiting to happen?
 M Rouss, For asset managers, good stewardship if good business, 2020.
 Investment Stewardship at Vanguard 2020
 Northern Trust stewardship report 2020
 Georg Kell’s Webinar on ‘Decarbonisation, Digitalization and Sustainability’
 S Brooke, Passive vs active: the ESG debate