If you were an advisor focused on environmental, social and governance corporate ratings you probably would not have been be surprised by the Vale dam collapse in Brazil, the bankruptcy filing by Pacific Gas & Electric in California, or the financial scandal at Nissan.
Problems at these companies were not new, according to Linda-Eling Lee, global head of ESG Research at MSCI, one of the major providers of ESG corporate ratings. “The track record was really there.”
Even if companies don’t file corporate social responsibility (CSR) reports annually — though an increasing number do — the information they contain is available elsewhere due to advances in big data and machine learning, and even reports from the Consumer Financial Protection Bureau, said Lee, referring to federal agency that in 2016 found Wells Fargo had opened 1.5 million unauthorized accounts. She was one of several members of a panel at the Inside ETFs conference in Hollywood, Florida, discussing the benefits of using ESG ratings when investing in securities, including equity indexes.
The track record is also there for ESG indexes, which in most cases slightly outperform traditional benchmarks and in some cases, like emerging markets, outperform by more than a little, said Lee.
Investing according to ESG principles can help financial advisors beyond performance and risk reduction in their client portfolios.
They can also help advisors “defend their investment choices to clients when those choices are out of favor,” said Vince Birley, CEO of Vident Financial.
And they align with clients’ focus on long-term returns, according to Birley. The metrics that drive long-term returns include value, quality earnings, cash flow, diversification and good leadership and governance — the “G” in ESG, said Birley, whose firm offers three ETFs based on those core principles: a U.S. and international equities ETF and fixed income ETF.
There is currently no common set of ESG principles and measures, but there are many companies providing ESG measurements and indexes, including MSCI, which Birley uses, as well as Nuveen.
“We use MSCI as sole data provider [because] we wanted a consistent application across all of our products,” said Jordan Farris, head of ETF product development at Nuveen, which uses ESG across portfolios rather than in discrete ETFs and funds, as many other asset managers do.
Nuveen also differentiates itself in the ESG space by having a dedicated team that engages with companies on ESG issues, including proxy voting, which is a growing issue for ESG ETFs, especially index funds. They traditionally tend to be less engaged in proxy votes.
A recent working paper by researchers at the University of Amsterdam’s Corpnet research group found that the big three asset managers — BlackRock, Vanguard and State Street — voted in favor of management proposals for share buybacks and mergers and acquisitions even when those proposals could be considered harmful to shareholders’ best interests, and even though the current BlackRock CEO and former State Street CEO have been vocal proponents of ESG-related issues.
To date, the U.S. trails Europe in the use of sustainable and ESG products as well as regulation, according to Fiona Bassett, global co-head of passive asset management and of the product group for DWS Group, formerly Deutsche Asset Management, also on the Inside ETFs panel. DWS uses multiple sources for its ESG analyses and is the first asset manager to offer an ESG money market fund in the U.S.
The European Commission is currently considering requiring that portfolio managers and financial advisors take into account client sustainability preferences in selection of products offered to relevant clients under its latest version of the Markets in Financial Instruments Directive (MiFID).
In the U.S., ESG remains strictly voluntary among asset managers and advisors. Birley doesn’t expect a big increase in demand until “advisors can can reshape the conversation from how a client is doing from year to year to 10 years at a time.”
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