Two major investing themes dominate the conversation in the investment management industry these days: passive investing and ESG investing.
Morningstar reports that total assets in passive stock funds eclipsed actively managed funds for the first time in August of 2019. ESG investing is also growing rapidly, comprising about 25 per cent of all funds under professional management, according to various estimates.
Passive investing started to take hold early in my career, and I have watched its inexorable growth with admiration.
As in politics, simple, understandable, and repeatable marketing messaging that is brought to life when certain trends or circumstances capture the popular imagination works just as well in investment management to reach the end audience.
This was a concept well understood – he built an industry powerhouse on it, after all – by the late Jack Bogle.
Passive investing represents an easy concept to understand: the lowest fees, “you own the market,” and a constant and consistent message from its proponents of “over the long term, the vast majority of active managers can’t beat the market.”
Now the industry is faced with a new analysis challenge in the shape of ESG – one that demands higher levels of analysis and rigour than perhaps is required in the realm of passive investing.
So, can ESG investing match the passive investing marketing message? To date, clearly not.
ESG investing has often been defined, not so much by globally accepted and agreed definitions and standards but, to paraphrase a US Supreme Court justice, as “I know it when I see it.”
There is also a lack of agreement on just what is meant by “ESG investing.” Many terms come into play: sustainable investing, impact investing, socially responsible investing, and more.
Many investors think they can “do good” by investing with one of these objectives in mind.
Clearly, the investment industry needs to do more to help explain the landscape to investors and help them understand some critical trade-offs they may be making when investing in products that are labeled ESG.
For many years, most ESG investors only focused on the G: governance. Board composition, executive compensation, poison pills, and the like. Best practices could be fairly well-defined and agreed by most market participants.
The challenges that society faces from climate change and environmental degradation have directed more attention the E: environmental factors. And that gets much more complicated.
While governance issues remain fairly straightforward, embracing environmental factors as a component in fundamental investment analysis muddies the equation.
It is easy enough for an investor to seek to exclude, say, coal stocks when building a portfolio. Negative screening certainly achieves that goal.
But a corporation’s environmental footprint is much more complicated than that.