Having passive ESG investment funds enter the market is a good thing for active managers because it stops them from becoming “lazy”, according to 7IM’s Jack Turner.
ESG – environmental, social and governance – and sustainable investment portfolios have seen significant inflows over the past 12 months following a run of strong performance during the pandemic and a shift in investors’ preferences.
This has been in tandem with the launch of a large number of ESG portfolios in the market, both active and passive.
There are questions about how well passives can satisfy investor’s ESG investment requirements, as they invest in parts of the index which might disagree with an individual’s ideals. Trustnet previously found that some sustainability indices contain the classic ‘sin stocks’ such as mining, airline, and tobacco companies.
But one thing ESG passives can do is hold active managers to account for generating outperformance, Turner said, by acting as a comparison.
Turner noted that the amount of passive options in the ESG space has “exploded” in the last couple of years.
“I think that's a good thing for the market. I think it keeps the active managers honest. I think it was too easy to be a good active manager in this space over the last five or 10 years,” he said.
“Now there's some really good passive funds out there which are using some of the big data providers to screen for the best companies out there. So the active managers have to do that a little bit more to outperform those particular products, which I think is a good thing. I think that's definitely a growth area.”
Turner added that this doesn’t mean active managers have no role in the sustainable investment space, which he felt was “very fertile ground” for them.
“I just don't think it should just be a default option that you go active in the space. I just don’t agree with that. And that's not good for anyone, because it's going to create a lot of that lazy active managers and I don’t think that that’s good either,” he said.
Investment firm 7IM has been invested in the sustainable part of the market for over a decade, with the FE fundinfo Five Crown rated 7IM Sustainable Balance fund launched in 2007.
The firm fully integrates sustainable and ESG investment criteria across its product range, with all parts of the process taking on an ESG focus and ESG risk assessments.
Along with the rise of passive investment options, Turner said that there have been other changes in the sustainable part of the market during the past 10 years, for better and worse.
One of the major problems has been the rise in “greenwashing”, which Turner said is being driven by the demand for new products.
“One of the drawbacks is just the level of greenwashing,” he said. “The market wasn't there five years ago, so there wasn't the incentive just to launch stuff for the sake of it. People launching products five, 10, even 14 years ago were in it for actual good reasons.
“But now, there's a huge level of demand out there. And so you're getting products kind of screened, and kind of re-dressed up as a kind of green investments. We see it all the time. So that's something you have to be very, very wary of.”
Even with the greenwashing issues, the wider range of genuine ESG and sustainable products coming to market in the past few years has been the main positive change, Turner said.
“I think if you're going back now even just five or six, seven years ago, there wasn't that many products available in the fixed income space, for example. But you're seeing a lot more kind of product issuance in that area,” Turner said,
This has partly been driven by improvements in the quality of data and the amount of data providers available for analysing companies and managers specifically from an ESG viewpoint. Turner added that the increase in passive products was also linked to the better data availability today.
Looking ahead and Turner said that there were a couple of main drivers for the sustainable investment space.
One, is the regulation around ESG and climate risk assessment being enacted. “We’re getting pushed to do this anyway, like it or not,” Turner said.
Second, is continuing high demand for this type of investment. “You've got the general the performance side of things,” he said.
“I think that this can be credited to companies which score highly on environmental and social factors. I think in time it will just be built in with your normal valuation metrics, like price to earnings and credit profiling of underlying issuers. I think that's the way it’s going to be, and I think that is just going to become the normal I expect well, at least kind of normal ESG integration.”