Active versus Passive Asset Management ESG Strategies

The index companies recently reported that around 25% of total ETF inflows were driven by ESG. What do you think is the real underlying driver of this?

There’s a massive inflow of capital from active management to passive management. A significant amount, roughly around 25%, is going into a particular variant of that, which incorporates environmental, social and governance information. I think there’s a number of things going on here. The move from passive to active itself, I believe, is largely fee driven. This is the notion that, over the years, to be brutally honest, active managers, in aggregate, have disappointed with the outcomes that they have produced for savers and beneficiaries. Particularly, the movement towards incorporating ESG factors is driven by savers’ and clients’ desire to ensure that their capital is trying to achieve a broader, holistic return, beyond a simple financial outcome.

Is this growth mainly driven by the actual owner of the asset?

Yes; this is really being driven, I think, by the end beneficiaries, which are pensioners and savers. I think there’s also a little bit of government incentive to move in this direction. We see various regulations where asset owners are not quite mandated, but getting very close to that. But they are certainly required to take account of ESG factors, as they make their investment decisions.

What is your view on the ESG ETFs that we’ve seen today? I think there has been a lot of negative press claiming that eight of the top 10 ESG funds still hold fossil fuel companies, which seems a bit counter-intuitive to the concept.

I think the future of asset management is going to see three different strands of asset management. Clearly, passive is going to be a growing and increasing component and that’s going to carry on for decades to come. Secondly you move into, what I would call, a systematic or alternative beta management, which is recognising that, whereas passive only observes a strict market factor, systematic beta says that there are other factors out there, which I can replicate, in a systematic way, for low cost. Then there will be a much smaller rump of active management that we have today.

Those three strands lend themselves, very well, to three different types of ESG integration. Passive, for example, fits very well with simple screening strategies. That is where, either in a negative basis, a manager screens out whole sectors or industries or, perhaps, even specific companies, that are believed to be non-ESG. For systematic beta, there is more of a quantitative approach. Here, there will be a trade-off between the potential reward of the factors, alongside these ESG elements, which will drive the construction of the portfolio. Lastly, for active management, you’re moving into this world of stewardship, of active engagement with the companies. Those two activities go very well together, as well.

Coming back to this idea that many of the largest ESG ETFs will contain fossil fuel companies, I think that’s okay, if there is an active stewardship programme behind those ETFs that is seeking to transform and nudge those fossil fuel companies towards renewable energy as being the future. That movement has to be fast; it has to be at least in line with Paris and it has to be absolutely transparent to end investors and I think there is a lot of difficulty around that.