PassiveOct 4 2018

Active versus passive when investing ethically

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Rathbones
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Supported by
Rathbones
Active versus passive when investing ethically

For a while, the active versus passive debate in the asset management industry became quite heated.

Naturally, there have been plenty of people in the industry who say a combination of actively-managed funds and products that track an index at a much lower cost can work in an investment portfolio.

But there are many people in asset management who hold strong views about one or the other investment approach.

While this debate has cooled somewhat, advisers with clients who are considering how to invest ethically or sustainably may want to know whether a passive approach might well be a more efficient way of doing so than via actively-managed products.

Firstly, can it be done? In a word, yes.

“The decision to invest passively or actively should be independent of the decision to invest sustainably given that there are a number of both active and passive strategies that are strong from a sustainable investing (SI) perspective,” says Christopher Greenwald, head of sustainable investment research and stewardship at UBS Asset Management. 

Clearly, passives have the edge when it comes to price and simplicity – but their simplicity is also their greatest challenge in the SRI market.Julia Dreblow

“Passive SI can be an easier place for investors to start, as they are going to obtain similar risk and return profiles of the overall market while having a stronger sustainability performance.”

But he notes: “Active SI strategies have the advantage of being more concentrated and, thus, it is generally easier for clients to understand the role that sustainability plays in the investment process, which is reflected in a more limited set of portfolio holdings.”

Mr Greenwald explains the performance of passive strategies is generally in line with the underlying benchmark, and the performance for active SI managers varies across different funds, “just as it varies across managers of traditional active funds”.

Price and simplicity

Passive strategies have the obvious advantage of being cheaper but, for many, there are limitations that can only be overcome by investing in an active fund.

Julia Dreblow, founder of sriServices and Fund EcoMarket, points to some of the pros and cons.

“Clearly, passives have the edge when it comes to price and simplicity – but their simplicity is also their greatest challenge in the SRI market,” she suggests.

“Values-based judgements and factoring in information about how company management is responding to a diverse range of ESG [environmental, social and governance] risks and opportunities requires case-by-case consideration – and the ability to respond to clients’ questions when asked.” 

She says: “Passive funds are generally not well-equipped to handle such things and are generally expected to invest in areas that are unpopular with ethically minded investors.”

John David, head of investments at Rathbone Greenbank Investments, observes there are few passive ethical funds, and says those that do exist are often based on responsible investment indices, “which may not be sufficiently ethically-screened for some investors”.

There is also the argument that investing in ESG strategies using a passive instrument goes against what this type of investment approach stands for, which is active engagement in environmental and social issues.

Mr David explains: “For many ethical investors, ethical investment is about promoting positive change and a more active approach allows this through more robust voting and engagement. 

“Active managers can sell a stock if their engagement is rebuffed; passive managers cannot. 

“Even among ethical funds, approaches will vary, and positive and negative screens, and engagement policies will differ.”

He reiterates: “It’s important to understand what is being offered and that it is being delivered effectively.”

Hands off?

Amanda Tovey, expands on some of the constraints of passive ethical funds.

“A passive fund will most likely be rebalanced at regular intervals, for example quarterly, and constituents checked at the same time to make sure they still meet the fund’s criteria,” she explains. 

“This means there is no active oversight in between, so if a company acts in a way that should exclude them from the fund it will then take some time for this exclusion to filter through. 

“It will also most likely mean there is no manager who is actively engaged with the company and its management, discussing areas of concern such as social or environmental policies, lobbying for improvement in areas where it could do better and actively voting at AGMs.”

In comparison, Ms Tovey suggests active managers will be much more “involved in these areas”.

She suggests: “As with all funds there will be times when passives outperform and times when actives outperform. 

“However, in this space we believe active management is particularly important to ensure fund managers are actively engaged with the companies they are invested in and to provide a positive investment overlay.”

But Ms Dreblow does not want it to become a case of active versus passive.

She acknowledges: “Unlike other investment markets, I am hopeful this will not become a battleground between passive and active strategies. 

“My expectation is because SRI assets under management lag client interest so significantly, there is room for growth across all areas – particularly where materiality is a factor.”

eleanor.duncan@ft.com