Environmental, social and governance (ESG) principles are integrated throughout Invesco says Chris Mellor, Head of Equity and Commodity ETF Product Management, Invesco.
The firm’s recent launch of four new ESG products mirrors the way that Invesco manages its total assets of USD1.2 trillion (data as at 30 September 2019), with all the securities they manage on behalf of end investors included in their proxy voting programme which has an ESG component.
The firm has been running portfolios with an ESG focus for more than 30 years, starting with portfolios run by the quantitative team out of Frankfurt to fulfil mandates for clients looking for specific ESG criteria.
The main driver behind launching the ESG ETFs was customer demand. Mellor says: “We have been getting more and more questions from clients and more enquiries as to what we have in that space, and now we are at a point in terms of development in ESG usage that there is enough demand from investors that a pooled vehicle could actually work effectively.”
ESG started out as an area of focus for early adopters who had strong views on exactly what they wanted or didn’t want in their portfolios, and they would use mandates to get that, Mellor says.
“Now more investors have a bigger focus on ESG, and the focus is not just on people offering investment products but also on asset owners who ultimately make the decision of where to invest.”
The pull is societal, Mellor says. “Greta Thunberg is obviously a recent catalyst for movement around climate change and more and more youngsters are coming from the mind set where they are less clear cut or stark on specific definitions of ESG compared with the early adopters. So, there is a coalescence around what is or isn’t acceptable and what are good ways to integrate ESG in a portfolio.”
Mellor explains that ESG ETFs generally come from two different positions. One group, such as the MSCI ESG Universal indices, offers core beta replacement for investors’ portfolios. While another group is what Mellor calls a ‘darker green’ with stronger ESG constraints and exposures.
“There are lots of investors out there who are relatively new to ESG and still need to think in terms of benchmarks and performance, so they have a tug of war going on with the desire to include ESG criteria but the problem of accepting the bigger tracking error from the benchmark that this potentially produces,” Mellor says.
The MSCI SRI indices for example, are a ‘darker green’ option leading to tracking errors of up to 1.8 per cent, Mellor says. “It’s quite a lot of benchmark risk to be taking. When we looked at the area there was nothing for the investor who wants to add ESG but doesn’t want to take too many off-benchmark bets.”
The MSCI Universal indices offer a “lighter green” approach, using ESG scoring and ESG score momentum to adjust the weights of the stocks in the portfolio. The standard version of these indices also filter out companies which have been involved in severe controversies and those which make controversial weapons.
“The problem for this standard approach is that you could still own companies involved in some ethically difficult areas such as tobacco or weapons, so fund providers can add exclusions to the indices that most investors would agree on: removing all types of weapons, tobacco, thermal coal and oil sands.”
“This approach has outperformed slightly over the back-tested periods,” Mellor says. “However, these ESG products aren’t designed to outperform but to give you an efficient ESG exposure. That said, there is in my view good evidence out there now that suggests a positive link between ESG momentum and performance.”
Effectively, the ESG filters help an investor avoid company specific risk or risk that wouldn’t be picked up by other factors. Mellor cites the fact that the MSCI ESG score was low for BP before the company had the Deepwater Horizon oil spill, or for Volkswagen, which had a low ESG score prior to its emissions’ scandal.
“If you run the numbers across a more statistically relevant sample, as the researchers have, they typically find evidence of outperformance from ESG portfolios,” Mellor says.
Mellor reports that feedback from investors on Invesco’s ESG range has been very positive. “Most investors have ESG on their radar, the degree of inclusion depends on where in the world you go,” he says. “Travelling around Europe, you find that ESG is firmly embedded in most investor approaches in Scandinavia and the Netherlands these days. They have an understanding of why we launched this.”
Mellor confirms that the plans are to expand the core beta ESG exposure and to add more ESG products in the space with a “darker green” tint. “Ultimately our aim is to provide products that meet our clients’ needs and ESG products fit one portion of the portfolio – there are other areas we are looking to address in the near future as well. Definitely watch this space.”
Head of EMEA ETF Equity & Commodity Product Management, Invesco
Chris Mellor leads the EMEA ETF equity and commodity product management team at Invesco, responsible for providing support and analysis for the range of equity and commodity ETFs. Before joining Invesco he worked as an investment strategist, focusing on market timing and tactical allocation across regions, sectors and styles for Sunrise, State Street Global Markets, Credit Suisse and Societe Generale. Chris holds a Doctor of Philosophy in Inorganic Chemistry from Balliol College, Oxford. He is also a charterholder of the CFA Institute.
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