Analysis: Asset owners are jostling passive funds to go green

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  • ESG ETFs now account for 18% of assets traded on Xetra
  • More asset owners are pledging to help achieve net zero
  • ESG passive boom can mean more exclusion, less engagement

LONDON, Feb 3 (Reuters) – When the local authority pension fund in East Sussex, southern England, wanted to reduce its exposure to fossil fuels, it had to make sure it there were no oil and gas stocks in the benchmarks tracked by its passive funds.

For example, the program recently swapped 200 million pounds ($271 million) from a passive fund that tracked a traditional stock market index to one that excludes oil, gas and coal companies.

That has helped it reduce its exposure to fossil fuels to less than 2% of assets today – down from 6% in 2016 – said Gerard Fox, chairman of the pension fund committee for the $4.6bn scheme. pounds, which has 78,000 mostly local governments. members.

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“Probably the biggest fiduciary risk for the energy transition portfolio is unwitting exposure to distressed companies and sectors through passive funds,” Fox told Reuters.

The East Sussex pension fund is one of many asset owners shifting their passive holdings to investment-tracking indices that promise to incorporate environmental, social and governance (ESG) factors, for example excluding certain industries and businesses – as part of a global campaign to reach net zero emissions.

For years, the way to do this was to put more money into ESG-aligned, actively managed funds, where managers promise selective equity investments to beat index performance.

More recently, there has been a surge in the number of ESG-focused investment tracking indices, including through exchange-traded funds (ETFs).

Crucially, it will likely mean more investors selling companies that don’t make the cut for their ESG indices, potentially reducing their power to engage with companies to push them to become greener in their operations.

In 2021, the share of all ETF assets held in products with an ESG label jumped to 18%, from 10% in 2020, according to data from Deutsche Borse. In 2017, the share was less than 1%.

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Investors have invested record amounts in ESG ETFs, and asset managers have also converted their traditional funds into ESG-friendly products by changing the index they track.

The trend is particularly pronounced in Europe – Amundi (AMUN.PA), Europe’s largest asset manager, said 95% of all net inflows into its ETF range last year went to funds ESG.

Overall, more than half of market-wide net flows into European-domiciled equity ETFs went to ESG-labeled funds, while two-thirds of new ETF launches were ESG-labelled. according to data from State Street Global Advisors.

Manuela Sperandeo, head of sustainable indexing for Europe, the Middle East and Africa at BlackRock (BLK.N), the world’s largest asset manager, said a better understanding of index track records , “better data availability around net zero, as well as sustainability ‘regulatory impulse’ would accelerate the trend in 2022.

BlackRock has been working with a growing number of asset owners to move their passive holdings to ESG-aligned benchmarks, she said, citing agreements with Oxford University and ongoing discussions with several Nordic and Dutch asset owners on the move to a climate benchmark.

While the bulk of ESG change is in equities, where benchmarks have a longer track record, Sperandeo said investors will increasingly look to do the same for fixed income and other parts of the world. their portfolio.

MORE SALES, LESS COMMITMENT

Passive investing has transformed markets as investors — preferring shadow indices to stock picking — pour money into lower-cost funds run by industry giants including BlackRock and Vanguard. Index funds now control about half of the US mutual fund market.

The growth of passive ESG funds is important because it will mean widespread selling off of companies that don’t make a difference to new benchmarks, such as companies excluded from the East Sussex Pension Fund’s ex-fossil fuel strategy run by Osmosis InvestmentManagement.

As near-permanent holders of a company’s stock, passive managers use their power to engage with ESG laggards, so any dilution of their holdings could hamper that ability, leaving active managers concerned about sustainability. take over.

“Once you have excluded a company, you no longer have leverage,” said Matthieu Guignard, global head of product development and capital markets at Amundi ETF, Indexing & Smart Beta.

Guignard said “tilting” index weightings away from laggards was one way to address this issue, as investors could still lobby corporate boards for greater climate action.

“Some investors really want to stay invested, they want to stay Universal Owners and drive change through engagement efforts, down to others who really want to divest very quickly right now. That’s the European lens,” said BlackRock’s Sperandeo.

For East Sussex, fossil fuel companies are unlikely to find their way back into passive portfolios unless they go green themselves.

But Fox said the program does not believe in “global divestment of the entire portfolio,” and that exposure to fossil fuels should be limited to active managers who engage with companies.

($1 = 0.7377 pounds)

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Reporting by Tommy Wilkes and Simon Jessop; Editing by Sujata Rao and Emelia Sithole-Matarise

Our standards: The Thomson Reuters Trust Principles.

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