Demand for Off-The-Peg ESG is Growing in Europe

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Demand for Off-The-Peg ESG is Growing in Europe


But ethical portfolios aimed at investors with less to spend face challenges

August 2019, LONDON - Fund providers are starting to introduce off-the-peg, managed ethical portfolios in low-cost solutions to meet the surge in interest in environmental, social, and governance (ESG) investment—but, the latest research from The Cerulli Edge—Global Edition, indicates that there are hurdles, including ensuring diversification and liquidity.

According to Cerulli Associates, a global research and consulting firm, one of the biggest issues affecting the rollout of ready-made ESG portfolios relates to passive ESG investment in fixed income. There are few sustainable bond funds, and ESG integration in sovereign bonds, which make up the bulk of the fixed-income market, is limited.

Investors’ approaches vary. For some, the positive role a government plays in, say, healthcare, education, or the wider common good compensates for its spending on defense or contentious foreign policy. For others, however, investing in emerging market government bonds requires an ESG rating and in-depth research.

“The bond issue goes to the heart of the challenge facing these ready-made portfolios,” says Fabrizio Zumbo, associate director, European asset management research at Cerulli. “Ethical investing is subjective, but low-cost portfolios designed for those with less to invest are not bespoke and often include products that some ethical investors would not wish to buy.”

Issues around how ESG products are constructed and the extent to which they match clients’ expectations are contributing to the decision of some managers to delay launching passive ethical funds.

One of the problems with tracking an index is the lag between news that a company has flouted ESG standards and reaction from the index. Indices typically rebalance every quarter, so it can take up to three months for a laggard to be dropped; the implications of this time lag are a deterrent for some investors.

Wider diversification across other asset classes can also be problematic, given the scarcity of ESG products available to build a multi-asset portfolio and ensure liquidity, with some diversifying allocations out of bounds altogether. For example, portfolios including commodities or derivatives— where aggressive short selling, which is is rarely deemed ethical, is common—are controversial.

Despite the difficulties, Cerulli expects growing standardization in the sector, followed by mass customization. “Progress around new products and strategies, take-up, and rollout is slow, but it will not be too long before there are enough products available for investors to select portfolios that match their own individual values and concerns,” says Zumbo.


OTHER FINDINGS:

  • ESG investing has gained momentum among Japan’s institutions, especially the Government Pension Investment Fund (GPIF), in recent years. However, Cerulli has found that, whereas Japanese public pensions are keen to follow the GPIF’s example, the country’s corporate pension funds are still hesitant about ESG investing. On the retail side, there is limited interest in ESG products in Japan.
  • A growing number of asset managers in the U.S. are using active ownership to address ESG issues. Almost all (96%) of the firms surveyed by Cerulli reported that they are voting via proxies to spur change and 78% are engaging in dialogue with management. Many of the asset managers Cerulli has spoken to have pointed to workforce and board diversity (race, ethnicity, gender) as a top focus of their active ownership efforts.

 

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NOTES TO EDITORS:

These findings and more are from: The Cerulli Edge—Global Edition, August 2019 Issue.

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