Sustainable Investing Opinion Briefs: September 1, 2018 – September 15, 2018

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Sept. 13, 2018 – According to Kate Beioley’s article in the Financial Times entitled “Robo advisors short circuit over ethical investors” a rift is emerging between rival robo-advisors in the UK over the suitability of ready-made ethical investment portfolios. According to the article, several platforms are arguing that the market is not mature enough to support fully diversified products. In August, online investment company Wealthify.com became the latest to offer investors a suite of on the shelf ethical portfolios. At the same time, rival robo-advisor firms, including Nutmeg, Moneyfarm and IG, claim that the market is still too young to be able to offer reliable and well diversified passive investment portfolios in this area. They note that there is no set definition of what an ethical fund or portfolio should do.  According to Moneyfarm, there are not yet enough green ETFs to put together a balanced portfolio while Scalable Capital, another robo-advisor firm, said there was not a sufficient spread of green ETFs across a variety of asset classes and regions, and the ethical ETFs on the market had not been around for long enough to provide enough performance and risk data. Nutmeg, the largest robo-advisor in the UK, opined in the article that the subjective nature of ethical investing, and the vast array of definitions used by different fund providers meant it would be too difficult to put together an ethical portfolio to please all customers. “What constitutes an ‘ethical’ strategy has no set definition and what makes an ethical portfolio for one provider doesn’t necessarily apply for another,” said James McManus, head of ETF research at Nutmeg. Other robo-advisor platforms offering ethical portfolios argued that having a clear and transparent method for selecting ethical funds was more important than having a single definition agreed by all providers. Fintech providers including Wealthsimple, Moola and PensionBee have all brought out ethical fund portfolios in recent months.

Wealthify.com’s five ethical portfolios, which match different risk appetites, exclude companies that engage in activities like gambling and tobacco and instead focus on companies that rank highly in environmental and social criteria, via a range of dedicated ethical investment funds from providers, including BlackRock and Kames Capital.

While we agree that the definition of what constitutes an ethical fund or an ethical portfolio is still up in the air and investor sustainability profiles and expectations differ from one person to the next, there are, at this point, in our view, a sufficient number of mutual fund and ETF product offerings in the US that can be combined to establish a core portfolio for many types of investors. That said, the number of effective products offerings is still limited and these have to be evaluated in concert with an effective screening of each investor’s sustainability preferences and goals alongside and assessment of financial objectives and risk tolerance.

Sept. 4, 2018 – Mark Latham reports on a survey conducted by Sustainable Ventures that 30% of European institutional investors plan to increase their sustainable investment “exposure over the next 2 years”.  Meanwhile, 7% of “sophisticated investors” also plan to do so.  The main reasons for doing so include: “wanting to do more to support sustainable companies” (53%) and “growing evidence that sustainable investments out-perform non-sustainable ones” (38%). We think it’s notable that these responses are coming from a more knowledgeable and experienced investor group.  If anything, institutional investors can be considered more thorough and adept at analyzing investment considerations, and not easily swayed.

Sept. 4, 2018 – The practice by fund companies of rebranding existing funds into sustainable or ESG products is on the rise (So far this year, 52 funds with net assets of $42.9 billion, or 71% of the gain in net assets by the sustainable segment according to Sustainable Research and Analysis LLCA). In some cases, fund companies simply change their existing product names with an “ethical allusion”, while not making any adjustment to portfolio holdings.  According to a WSJournal article “It is Difficult to be an ‘Ethical’ Investor” by Jon Sindreu and Sarah Kent, the lack of “regulation governing” or “what a fund manager can call a ‘socially responsible’ or ‘ethical investment’ doesn’t help. We agree and would add that “playing-lose” with defining sustainable investment funds could result in significant problems at the fund company- and even at the fund industry-level. It can be considered a violation of investor trust. That said, managers should have some leeway in defining their sustainable investing processes and portfolio restrictions, but some standardized portfolio guidelines, definitions, and disclosures are advised. Further, whereas prospectus amendments or changes to a fund’s investment objectives may be made without shareholder approval to the extent that these are not deemed to be fundamental, the ESG changes referenced above do invite questions about the opportunity that fund investors more generally should have to express their approval for these types of modifications when the adoption of ESG factors could potentially impact current and future fund practices, portfolio holdings as well as investment performance results. Also, investors might incur additional expenses in the event that securities have to be sold to comply with updated ESG guidelines.

Sept. 3, 2018 – A Barron’s article by Crystal Kim on zero fund fees, suggests that “Direct indexing is particularly well suited” for ESG investing.  She reports that this is because those interested in ESG funds often have specific investment interests not able to be met by “one-size-fits-all strategies.”  Direct indexing, however, does allow for building customized accounts and potentially offers investors tax advantages while at the same time reducing or even eliminating liquidity risks.  Costs aside, we think that direct ESG indexing clearly has potential for some investors, especially high net worth clients but may not be adaptable to all retail market investors and is an unlikely solution, at least today, for most defined contribution plans. Additionally, not all management companies are believed to have the business capabilities to offer them.

August 29, 2018 – Bloomberg reports that stocks dominate ESG investment funds.  For sustainable-oriented funds more generally, this may in part be due to the lack of ESG fixed income investments and the complexity of applying sustainability criteria to fixed income instruments.  Emily Chasen reports that only 15% of ESG funds and 3% of ESG fund assets are invested in fixed income securities (based on data applicable to US mutual funds and ETFs combined, 8.6% of total assets are invested in fixed income products as of 8/31/2018).  As a consequence, asset managers are “tapping into potentially overlooked asset classes” including, muni bonds, community development financial institutions (“CDFI”), green bonds and ESG-rated bond portfolios to populate their fund portfolios. We are not surprised by the equity tilt ESG fund product leaning, and for reasons other than performance.  From a fund sales standpoint, equity-based funds have generally been more attractive to investors in general, for reasons for performance.  But we recognize that as the challenges of applying ESG in fixed income are overcome, and asset allocation and retirement platforms take hold, ESG fixed-income strategies will catch up.

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