July 5, 2020

Monday Morning Memo: ESG Strategies—What Investors Expect From ETFs

by Detlef Glow.

The growth of sustainable investing is constantly accelerating and can be seen as one of the most important growth drivers for the fund industry over the next few years. From my point of view, we may reach the breaking point where the majority of assets are managed with a sustainability-based approach rather than in a conventional way within the next five years. Aside from new fund launches, one of the drivers for this massive shift is the repurposing of mutual funds, since especially in Europe an increasing number of conventional funds have started to integrate environmental, social and governance (ESG) criteria into their investment processes and are, therefore, considered to be sustainable or ESG funds.Since the ETF industry is quite fast in translating investor trends into products, it is not surprising that we have seen a constant stream of new ESG-related products within this product segment. But opposite to other market or product trends, the latest TrackInsight ETF Professional Investors Survey 2020—conducted by TrackInsight in conjunction with IHS Markit and iShares by BlackRock—shows that there is a real demand for these products in the investor community.

ETFs accelerating the trend toward ESG investing

In fact, ESG was the top priority when professional investors were asked which products they would like to see filling the shelves of ETF promoters, followed by thematic exposures and risk-based solutions. Eighty-six percent of the recipients of the TrackInsight survey want to increase their exposure to ESG ETFs. Twelve percent want to leave their exposure as it is, while only 2% want to reduce their exposure by 5-20%.

When asked how satisfied they are with the range of ESG products, the professional ETF investors polled in the TrackInsight survey strongly believe that  product and index promoters need to sharpen their focus with regard to sustainable investments when it comes to more specific asset classes, such as emerging markets and high-yield bonds, to make an higher impact in these segments. Conversely, they believe that the industry seems to be heading in the right direction when it comes to mainstream, plain vanilla stocks and bonds, while those more exotic exposures raise complex questions related to their ESG assessment that few believe are properly addressed.

The demand for more solutions in the area of emerging markets and high-yield bonds is not surprising since bonds are way harder to evaluate from an ESG perspective than equities. This is especially true for more exotic markets, as these markets face in general a lack of transparency compared to developed markets.

As ETFs are in general based on a market benchmark, it is no surprise that index providers around the globe are launching new index families to meet the demand of investors. The latest examples of this are the new the STOXX Climate Transition (CTB) and Paris-Aligned Benchmarks (PAB), which are constructed to follow the EU Climate Benchmark (EU CTB and EU PAB) requirements. Thus, these new benchmarks may help investors to align their investments with the Paris Climate Agreement, or more generally may help them to shift their investments toward a low carbon economy.

With regard to the demand for more exotic products, I am sure that we will see launches of indices covering more exotic markets, as these might become cash cows for index as well as ETF promoters.

That said, 68% of the recipients in the TrackInsight survey see the missing consistency across ESG analysis providers and the lack of transparency and simplicity of ESG indices’ methodologies (64%) as the main challenges when investing in ESG ETFs. From my point of view, this means that the ETF and index promoters will have to increase their educational efforts and have to work on their communication strategies, as clarity on the criteria used to construct the respective index will be key for the success of the related products.

The fact that these additional efforts with regard to investor education can pay off in a great manner can also be derived from the TrackInsight survey, as 81% of the recipients said that they are using ETFs for their strategic, long-term asset allocation. In addition, 51% of the surveyed investors claimed that they used ETFs to replace actively managed funds. Just these two facts may justify a higher educational effort, as a number of investors are still not using ETFs or are reluctant because of the lack of information.

The views expressed are the views of the author and not necessarily those of Refinitiv. This material is provided as market commentary and for educational purposes only and does not constitute investment research or advice. Refinitiv cannot be held responsible for any direct or incidental loss resulting from applying any of the information provided in this publication or from any other source mentioned. Please consult with a qualified professional for financial advice.

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