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Can ETFs be serious ESG strategies?

Refinitiv's Detlef Glow explores claims active managers can evaluate companies faster and have better influence of boards

As ETFs become increasingly successful in gathering assets from ESG-oriented investors, active managers have started to claim that serious ESG strategies need active management. Since we know that similar claims from active managers over vanilla ETFs have been proven wrong in the past, one has to check if the new claims are true.

See also: – Is active vs passive ESG debate meaningless marketing?

One of the major claims of the critiques is that ESG indices, which are the basis for ESG ETFs, review their constituents only a few times a year and can’t in most cases react directly to controversies or scandals. Meanwhile, active managers can re-evaluate the respective company immediately after a controversy and sell their positions if necessary.

Generally speaking, this claim is true, but some index promoters have created rules that allow them to make off-cycle constituent reviews if necessary. This means the respective indices and ETFs can react if an index constituent no longer fulfills the criteria for inclusion within the respective index.

It will be only a question of time until all sustainability indices will implement index rules that will allow them to review their constituents on a higher frequency and employ policies that will allow them to react immediately if a constituent no longer meets the inclusion criteria of an index.

Quantitative screens

Another major claim of active managers is that sustainable indices normally only use quantitative screens to determine their constituents. This means they are supporting only those companies that are already acting sustainably and won’t drive the change towards more sustainable business practices at companies that don’t have an integrated sustainable strategy yet, or fail to report on their sustainable strategy, as corporate sustainability reports beside other data sources are the basis for the evaluation of companies.

This claim is also somewhat right, as a company has to have a sustainable strategy and need to fulfill the respective reporting requirements to become a member of an ESG index.

That said, even active managers need data to determine which companies they include within their portfolios. Therefore, this claim is only partly true.

Nevertheless, some active managers do have strong engagement strategies and try to influence the boards of companies within their portfolios to change their strategies or single business practices towards a higher sustainability measured by the standards of the respective asset manager.

Early stages

In general, these two claims by active managers are at least partly true. As we are still in an early phase of the evolution of passive ESG investing strategies, the promoters of ESG indices are already working on improvements to the rules for their existing ESG indices, which will tackle some of the weaknesses which have been addressed by critiques and investors.

In addition, index promoters will launch a new generation of indices that are not only aligned with regulations such as the Sustainable Finance Disclosures Regulation, or the Paris Climate Agreement, but may also include room for companies that just have started their journey towards higher sustainability standards for their manufacturing and/or products.