Switch to ESG indices has not pleased all European investors

The switch by many passive funds in Europe to indices with an environmental, social and governance tilt has left many professional fund selectors feeling wrongfooted, industry observers say.

Funds increasingly are including ESG considerations in their objectives as an ever-larger proportion of flows moves into sustainable products.

Some of Europe’s largest exchange traded fund providers, including iShares, DWS and BNP Paribas, have changed indices on some of their products.

Passive products classified as sustainable under EU finance rules had net inflows of €8.4bn in November alone, according to Morningstar data.

This article was previously published by Ignites Europe, a title owned by the FT Group.

But not all professional fund buyers are happy with passive funds being repurposed as sustainable.

Jose Garcia Zarate, associate director, passive strategies at Morningstar, said one portfolio manager he spoke to was “upset” that an ETF the company held had switched to an ESG index, which excluded energy company Shell.

The selector wanted to maintain exposure to the Anglo-Dutch oil and gas giant, said Garcia Zarate.

Some think investing in stocks excluded from ESG indices could be advantageous at a time when other investors are divesting from these companies, he added.

Chris Chancellor, senior director, global insights at Broadridge, said views of this kind among European fund selectors were “not common but not unknown”.

“Whilst it is easy to think the whole industry and all participants have shifted to ESG, it’s clearly not the case,” he said.

Detlef Glow, head of Europe, the Middle East and Africa research at Refinitiv Lipper, said: “I can understand that some investors are concerned when ETF promoters change the underlying indices of their ETFs since they may have a different investment objective than that of the new index.”

Glow said ETF providers “need to be careful when making the decision to repurpose an ETF” as this can have “massive impacts on the relationship between the ETF promoters and their investors”.

The issue for fund selectors goes beyond ESG considerations, according to Chancellor.

“Fund selectors hate funds being changed without prior warning,” he said.

“For [a fund] to change without prior warnings and conversation means [selectors] may have a fund that doesn’t fit with the reasons they added it to the portfolio.”

“Change with little warning creates a trust issue,” he added.

“If a change is forced on [a client] at short notice, that doesn’t feel like a partnership and you lose trust that is hard to build in the first place.”

A report from Broadridge quotes one anonymous Swiss discretionary manager as saying that they “particularly dislike it” when asset managers “convert their products into ESG and [socially responsible investment] products without our consent or notifying us beforehand”.

Nicolo Bragazza, senior investment analyst at Morningstar Investment Management, agreed, saying: “Clients need to be put in the best position to make investment decisions, and therefore clarity and transparency are key.”

To keep clients on board, asset managers may need to go above and beyond regulatory standards, which give investors time to redeem before a fund changes its investment objectives or benchmark index.

However, direct communications with ETF clients are not always straightforward, as Peter Sleep, a senior portfolio manager at multi-manager Seven Investment Management, pointed out.

“There are no conventional shareholder registers with ETFs, and issuers often do not know who their shareholders are,” Sleep said.

This means that some investors “may miss the change” in their ETF’s index, he said.

Deborah Fuhr, founder of consultancy ETFGI said there was “likely to be a lot of product proliferation globally” as a result of differing client views on ESG, as well as differing regulatory pressures.

*Ignites Europe is a news service published by FT Specialist for professionals working in the asset management industry. It covers everything from new product launches to regulations and industry trends. Trials and subscriptions are available at igniteseurope.com.

Click here to visit the ETF Hub