In their current form, ETFs and passive vehicles are not the right tool to place money into the market if you’re seeking to achieve both financial and positive impact return.
The growth of these low-cost vehicles is understandable in the context of poor performance from some active managers this year, so it can be understandably difficult for retail investors to select good active fund managers, and justify the higher fees they charge.
A recent Spiva report stated 45 percent of actively managed UK equity funds underperformed the S&P UK BMI benchmark year to date, a figure which increases to more than two-thirds if the period in question increases to 10 years.1
Investors seeking effective ESG and impact portfolios need to consider the significant limitations of relying on passive options for a number of reasons:
Blind index tracking
As it currently stands, passive strategies typically replicate an index without explicit engagement or stewardship on the companies within the index. This can leave passive strategies exposed to holdings at risk of poor ESG outcomes with limited opportunities to engage directly with all companies in the portfolio.
Relying on third party data
Many ETFs currently being marketed as impact or responsible or sustainable are relying solely on third party ESG data with little guided or expert interpretation. This results in these passive funds holding businesses whose practices and products are not sustainable and positively impactful.
Lack of shareholder engagement
Couple this with limited shareholder engagement and passive funds become as much a part of the problem as their holdings are. Investing for impact can’t be silent on what a company does. [We wrote about this recently] In an actively managed approach, engagement and stewardship is more easily achieved on more concentrated portfolios; baked into bottom-up stock selection, and in the case of impact active managers, the inclusion of explicit ESG and impact targets and outcomes.
Ignoring company disclosures
There’s enough disclosure out there for more passives to be doing a better job on sustainability. It appears, passive managers are either choosing to ignore the data in the marketplace or they’re not weighting it enough in their rules and the algorithms. With more data coming online and more disclosure by companies and other third parties, passive managers need to understand how to work with the data and incorporate it into their decision making.
Outperformance of active impact management
Furthermore, impact active asset managers have distinguished themselves this year in a market where non-sustainable active investors have had difficulty justifying their, typically, higher management fees compared to their passive alternatives. Our medium risk portfolio is up almost 10% this year, to end of Q3, an 11.7% outperformance relative to ARC.2
There are, however, some early signs of a response in the marketplace with some ETF providers beginning to acknowledge these limitations. Some passive specialists are building proprietary indices, populated with companies that have been subject to rigourous analysis and engagement, which in turn are being wrapped into an ETF, therefore offering investors a more cost-effective product.
But there are still certain compromises for these lower fees; most underlying indices are still only updated half yearly, and the degree of shareholder engagement through voting records, as an example, still needs significant development.
So, in a complex world, where the reality of business is non-linear, can passives truly reflect this data in a rules-based environment? Inputs into decision making today need to be multi-dimensional and based on finance, social, environmental, geopolitical, and economic factors.
Nuances in the data need to be appreciated as much as the data itself needs to be interrogated. Most fund managers aren’t equipped for this type of complexity, regardless of whether they’re passive or active managers.
That’s why we believe in our double CIO model (a chief investment officer and chief impact officer); investment and impact working closely together to identify and invest in tomorrow’s businesses, today.
We believe active management is still the best approach to risk adjusted good investing in the sustainable and impact investing space. Investors should not only get a higher level of risk management and investment opportunity identification, they also know that the companies they are exposed to are future fit.
2 Sources: Bloomberg and ARC data 1st January to 30th September
Important Information: Tribe Impact Capital LLP is authorised and regulated by the Financial Conduct Authority (“FCA”). Our FCA registration details are set out in the FCA Register under Firm Reference number 756411 (www.fca.org.uk). Tribe Impact Capital LLP is registered in England and Wales (registered number OC411984) and our registered office is 73 Cornhill, London EC3V 3QQ. This document does not provide you with enough information to make an informed investment decision. Neither does it constitute advice or a personal recommendation or take into account the particular investment objectives, financial situations or needs of individual clients. If you are not an existing client of Tribe Impact Capital LLP, this document is considered to be marketing material. Whilst this document may contain information about specific companies it is not an investment research report as defined by the FCA. This document is not intended and should not be construed as an offer, solicitation or recommendation to buy or sell any investments. You are recommended to seek advice concerning suitability of any intended investment decision from your investment adviser. Past performance is not a reliable indicator of future performance; and the value of investments, as well as the income from them can go down as well as up. Investors may get back less than the original amount invested. Any type of impact investment will involve risk to investors capital and the expected environmental or social return may not be achieved. The information and opinions expressed herein are based on current public information we believe to be reliable; but we do not represent that they are accurate or complete, and they should not be relied upon as such. Any information herein is given in good faith but is subject to change without notice. No liability is accepted whatsoever by Tribe Impact Capital LLP or its employees and associated companies for any direct or consequential loss arising from this document. This document is not for distribution outside the European Economic Area.