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Three funds in Europe’s growing large-cap ESG market

Morningstar examines Invesco Sustainable Pan European Structured Equity, a UBS ETF and Comgest Growth Europe

The Europe large-cap equity category housed 660 ESG-focused funds as of 31 July 2021.

In line with the rest of the market, Europe large-cap ESG funds grew 40% year on year and reached more than €260bn in net assets at the end of July. These assets account for roughly 11% of total assets in ESG funds domiciled in Europe.

This is only second to global large-cap equity funds, which concentrate just shy of 20% of the assets in ESG funds in the region. 

Here we examine three Europe large-cap equity funds awarded the ESG Commitment Level of Advanced. For these funds, sustainability considerations are a key part of the strategy and have investment teams that exhibit strong ESG credentials.

Invesco Sustainable Pan European Structured Equity

This is a quantitative approach with solid ESG integration and strong active ownership practices.

The multi-factor exposure low volatility quantitative strategy has integrated ESG considerations within the investment process since 2018, excluding companies with a two-notch downgrade of their ESG rating and targeting a portfolio ESG score at least equal to that of its MSCI Europe benchmark.

In April 2021, ESG integration was further enhanced with the adoption of a best-in-class approach and the introduction of additional exclusion criteria (around 30% of the investable universe is now excluded based on energy transition metrics).

Those changes are expected to meaningfully impact the portfolio going forward as ESG issues became the third consideration of this strategy (alongside low volatility and multi-factor exposure), prompting it to be rebranded as a sustainable offering.

Although experience in sustainable investing is still relatively limited among Invesco’s 60-member-strong quantitative strategies team, our conviction is further strengthened by the team’s use of advanced proprietary ESG tools and metrics as well as its active involvement in both proxy voting and engagement activities.

UBS MSCI EMU SRI ETF

The strict best-in-class ESG approach employed by UBS – MSCI EMU SRI means this is one of the most ESG-focused passive funds around. It replicates the MSCI EMU SRI index, which selects the top quartile of Eurozone stocks with the strongest ESG characteristics.

Additionally, any firm that is exposed to controversial lines of business, such as firearms, tobacco and nuclear power, or that violates the UN Global Compact principles is excluded from the get-go.

By focusing on the highest-scoring holdings in the universe, the fund demonstrates the strength of its ESG commitment over other less-discerning peers. It is worth noting that the index’s sector-relative stock-selection approach is designed to ensure that its performance doesn’t deviate drastically from the parent index (the MSCI EMU index), but it also means the fund invests in some sectors and stocks that might not meet everyone’s definition of sustainable. For example, the portfolio holds oil and gas company Neste Oyj.

Finally, the infrequent rebalancing built into the strategy means stocks that unexpectedly breach sustainability criteria may be held within the fund for some time before being excluded at the next quarterly index rebalance.

Comgest Growth Europe  

Comgest Growth Europe genuinely integrates ESG factors in its approach and has a sound active ownership programme. Integrating ESG criteria has been a natural extension of the fund’s well-ingrained quality-growth approach. The firm avoids the usual controversial sectors, i.e. controversial weapons, tobacco, and thermal coal.

Given the team’s stringent quality criteria, its investment universe is naturally tilted toward firms with above-average ESG practices in the first place. The team then uses ESG factors to identify growth opportunities for companies and assess risks that might threaten their long-term earnings power. The discount rates used in valuation models are systematically adjusted upward or downward according to a proprietary ESG quality rating, which impacts position sizing.

Admittedly, ESG resources at Comgest are thin, with only five ESG analysts, one of which provides research on European companies. In that context, it is reassuring that members of the European equity investment team are very involved with the ESG efforts, actively participating in the ESG research and being at the forefront of proxy voting and engagement activities. Engagement is selective, yet thorough, and reported back to investors in a comprehensive and transparent manner.