Engagement has supplanted exclusion as the most popular NZ responsible investment (RI) strategy for the first time, according to the latest annual review of the sector.
The Responsible Investment Association of Australasia (RIIA) 2020 ‘Benchmark report’ for NZ found than environmental, social and governance (ESG) integration topped negative screening as the most influential factor in creating RI portfolios.
Less than 10 per cent of those surveyed rated exclusions as among the most important strategies in RI portfolio construction, the RIIA report says.
“The findings show a shift in focus by survey respondents away from negative screening (44% in 2018) towards corporate engagement and shareholder action (40% in 2020),” the study says.
Despite the growing focus on ESG integration, however, the RIIA survey found exclusions remain a fundamental feature of the RI process.
“The frequency of negative screening has generally increased across all exclusionary themes, except genetic engineering,” the report says. “Screening for exposure to fossil fuel exploration, mining, extraction and production has almost doubled over the period (from 45% to 80% of all survey respondents who apply exclusionary screens).”
Overall, the study found a substantial increase in both the number of NZ investors included in the RI universe and the proportion of funds classed under the label in 2019 compared to the previous year.
Total assets under management identified as RI-like in NZ jumped from $188 billion in 2018 to almost $280 billion the following year. More than half (55 per cent) of the RI managers in NZ were “new in 2019”, the paper says.
But RIAA rated just $153.3 billion of the potential 2019 RI universe as “applying a leading approach”.
“New data points in 2019 indicate that there is still a gap between those that claim to be practising responsible investing and those that have embedded these practices through formal policies and accountability commitments including disclosing full portfolio holdings,” the report says.
Of the 58 managers included in the study – carried out by KPMG – only 14 met the RIAA ‘leading approach’ standards.
Nevertheless, the ‘leading’ RI money in NZ represents just over half of all funds under management, the report says.
The 2020 report (based on 2019 data) also includes NZ RI performance numbers for the first time – albeit based on a small sample size of between just one product and 20 depending on the asset class and time-period.
Diversified RI funds either equaled or slightly outperformed unadulterated comparative KiwiSaver products over the one-, three- and five-year periods after fees, the RIAA report says. However, over the 10-year stretch, KiwiSaver multi-sector funds returned 8 per cent versus 7 per cent for RI counterparts.
RIIA, headed by Simon O’Connor, has more than 300 members across Australia and NZ, accounting for some $9 trillion in assets under management.
In another study last week, research house Morningstar found while most ESG strategies – regardless of investor type – tended to be actively managed there has been a surge in passive options.
The Morningstar report found Europe remains the biggest such market but the US, historically slow to adopt ESG funds, has grown at twice the pace. For the rest of the world, Australia is second only to China in assets. New Zealand is sixth.
Morningstar identifies 534 index-tracking – passive – sustainable or ESG-influenced funds out of a total universe of 3,432 sustainable funds around the world. But there appear to be plenty of “runway” left for passive ESG funds. For instance, passive ESG funds make up only 12 per cent of all ESG funds, while passive funds in general make up 24 per cent of the overall market.
The 17 Australian passive sustainable funds totalled US$3.6 billion in assets as of June, following a surge in 2018 and a quieter year in 2019. Examining the most recent entrants to the list, Vanguard launched an ETF and an unlisted fund each in the equity and fixed-income segments during 2018, while VanEck came out with a sustainable equity ETF in the same year.
With nine offerings for investors, Vanguard is by far the largest provider of Australian passive sustainable funds with a market share of 65 per cent. These nine are all in the ‘exclusion-only’ category. The remaining eight offerings all belong to the ‘Broad ESG group’ − three funds provided by BetaShares, two by VanEck, and one fund each by BlackRock (iShares), Russell, and State Street.
The 534 sustainable passive funds represent US$250 billion in assets, with both their number and the assets under management doubling over the past three years since the last survey. Europe accounts for more than 75 per cent of the assets and the US, 20 per cent.
While New Zealand is ranked sixth in the world ex-Europe and the US for passive ESG-style funds, it has only one provider, SmartShares, which entered the space in 2017. It has US$99 million in sustainable assets at the end of June. In 2019, the manager launched five new ETFs for sustainable investing, which use an exclusion-only process.
The study also found most passive ESG funds used exclusion-only techniques while active managers generally applied positive tilts as well.
Morningstar says in the report: “The opacity of some ESG metrics can mean the true reasons for inclusion or exclusion are still tricky to ascertain. Some believe that, in its purest form, sustainable investment is only implementable by active managers. In some ways, the rigid nature of passive investing does not lend itself to the nuanced world of ESG. For example, liquidity constraints mean that passive strategies must steer clear of smaller, often more impactful, companies. Those seeking the most ESG impact might expect a level of engagement between fund management and portfolio company not possible in a passive wrapper.”
Tim Murphy, Morningstar director of manager research Asia Pacific, said that some asset owners might choose to have a systematic process but also an investment committee to oversee it and perhaps add a subjective input. But the opacity and complexities were not holding back the sector’s growth, he said.
With extra reporting by Greg Bright is publisher of Investor Strategy News (Australia)