The rise of index-based strategies and Exchange Traded Products (ETPs) represents a major shift in markets during the last decade, in tandem with a greater sense of urgency regarding adoption of responsible investing principles.
According to a recent report by Zenith Investment Partners, these two themes have resulted in the creation of hundreds of indices around the world focussing on a range of environmental, social and governance (ESG) factors and a surge in the number of ESG-focussed ETPs and Exchange Traded Funds (ETFs).
Mirroring global trends, the local ETP industry continued to expand rapidly. As at 30 September 2020, ETPs reached a market capitalisation of $A 71.1 billion, up 27% on the previous year. Against this backdrop of growth, it’s not surprising the market has responded with an increase in the number of ETPs with an ESG focus or screen, said Dugald Higgins, Zenith’s Head of Real Assets and Listed Strategies.
“Defining responsible investing is, by its nature, highly subjective and reliant on a framework of judgements on issues, implementation and stewardship. As a result, the debate is increasing from pundits on all side. Is true responsible investing possible via an index-based approach? We see a new battleground emerging in the old active versus passive debate,” said Dugald.
For investors who want to know exactly what they’re investing in, ETPs have two clear advantages. One is a clear set of rules about what can and can’t be included in a portfolio. The other is full daily transparency on all holdings.
“Given the subjectiveness of responsible investing and the fact that values are in the eye of the user, these can be highly attractive features for investors seeking to ensure a level of control over their investments using ETPs,” Dugald said.
“Conversely, the flow of ESG-related data means that ETPs can be somewhat backward-looking in choosing securities and tend to reflect more developed opportunities or exclusions. However, they have difficulty in capturing companies that are emerging in this space or transitioning to stronger ESG overlays, which can be where much of the ultimate impact lies. If investors are looking to identify companies that are improving in this space, ETPs may have more difficulty in capturing those opportunities.”
Stewardship capabilities are emerging as one of the fundamental differentiators between managers in both active and index-based strategies. However, for index managers who once used competition on fees as a major battleground, stewardship is arguably a more critical factor when operating a responsible investing strategy.
“Investors need to understand which managers have deep active engagement capabilities and how effective these are in ultimately shaping outcomes,” he said.
Zenith Investment Partners recently launched a responsible investing (RI) classification system across all rated products to better support advisers when assessing an investment product’s approach to RI. The system identifies the level of RI integration in the investment management process with reference to not only how managers assess and incorporate RI issues, but also their interaction and engagement with issuers of securities.