Invesco reports growing demand for ESG ETFs from insurers

ESG growth

Invesco reports that ETFs have become the vehicle of choice for institutional investors to integrate ESG criteria into their portfolios, with insurers switching to ESG via some investments in ETFs because they enable a combination of strict compliance with regulatory requirements, flexibility in their asset allocation, the fine-tuning of their ESG strategy, including the implementation of self-indexing mechanisms, at low cost.

Charles Moussier, EMEA Head of Insurance Investment Solutions at Invesco, says: “The driver behind ESG growth is coming from a need for the new generation, our children, who are wanting to save the planet and wanting to do the right thing and those values are coming to play in the investment world more and more.”

Analysis of asset allocation trends by Invesco shows that some major institutional investors – including insurers – have already switched a significant part of their portfolios to ESG strategies, with the Covid-19 crisis and the ensuing market volatility further propelling the trend towards ESG ETFs, a trend the firm expects to escalate going forward.

According to Moussier, the trend will accelerate. “I have been working on this since 2001 and it’s been quite slow. What is pushing the innovation in the financial services world is regulatory changes on the offer side which is key to building up the appetite of investors.”

Moussier explains that there are fundamental structural reasons for the growing attractiveness of ESG ETFs to insurers, most prominently regulatory developments and the intrinsic qualities of ETFs in terms of transparency, flexibility and cost.

ESG is featuring increasingly prominently in European insurers’ regulatory regime. The European Union’s new ESG reporting framework (Sustainable Finance Disclosure Regulation), which will come into force on 10 March 2021, will require EU-based insurers to publish a detailed ESG risk integration policy on their website.

But it’s not just seen as the right thing to do: performance can also be improved.

“In our view, adopting ESG is no longer seen by insurers as a constraint, but as an opportunity. This is highlighted by the fact that many insurers have gone even further than regulatory requirements in integrating the ESG dimension. ESG strategies have demonstrated their ability in recent years to reduce risk in turbulent markets, a principal objective for insurers,” he says.

Sustainable ETFs demonstrated their ability to outperform in difficult contexts in the turbulent first quarter of 2020, with Morningstar reporting that 24 out of 26 ESG ETFs outperformed their non-ESG peers during this period, Invesco reports. While this is partly due to lower exposure to the energy sector, resilience is ultimately a fundamental quality of these ESG funds, thanks often to crisis-resistant sectoral allocation strategies, the firm says.

Going forward, life insurers and all companies offering insurance-based investment products will also have to provide disclosures on how ESG risks have been taken into account, and their impact on value and performance, in pre-contractual documents for clients.

Insurers with more than 500 employees will also be required to disclose their policies concerning the negative ESG impacts of their investments. These insurers are also subject to the Non-Financial Reporting Directive, requiring them to disclose in the near future the percentage of investments financing green activities as defined by the EU Taxonomy, which defines sectors generating positive environmental impact.

Moussier says: “ESG strategies build a model of society for tomorrow. If insurers want to limit their long-term investment risk, being ESG compliant is the way to go. ESG is also a good way for insurers to communicate on their ‘raison d’être’ with employees and to solidify the long-term value for their shareholders: ultimately, insurers will have fewer claims to reimburse on their liability side of the business if climate change or pandemic can be altered. For instance, Swiss Re has just announced that it has put aside USD2.5 billion in additional reserves to pay for Covid-19 claims.”

Another type of regulation which will have its impact is the requirement, active now in France, that any financial products launched will have to have an ESG equivalent offering. “It’s the only way to make some change,” Moussier says.

ETFs have proved to be popular in providing the ESG filter with their intrinsic qualities of transparency, low costs and the ease of understanding. 

Moussier comments: “As we have seen through this crisis, ETFs have continued trading and offered liquidity – in both primary and secondary markets – under the most difficult conditions that investors have ever experienced.”

The RDR review in the UK has had a beneficial effect for ETF growth, as commissions funded by retro commissions from funds were clearly under the spotlight. Then the comparative advantage of the active management products vs. ETF in the old distribution model faded away, he says.

“The result is that insurance companies are diversifying into building ancillary services such as retirement planning supported by ETFs to keep the costs down.”

Another development has been the growth of self-indexing by insurance companies. Moussier explains: “One of the most exciting market developments is self-indexing. The ETF format is especially well suited for advances in defining and implementing ESG strategies which are well aligned with the specific needs of each insurer. This is what we call ‘self-indexation’, the aim being to create an index that complies with the ESG rules and strategies specific to each institution, since ESG approaches differ in the absence of a market standard.”

For Moussier, the power of self-indexing is that it allows insurance companies to develop their own asset management philosophy, allowing them to be independent from the asset managers. Invesco is actively building self-indexing solutions for insurance companies, assessing the performance and risk of their investments.

“We build an index which is credible,” he says. “We use a lot of investment experts and data which is what being an asset manager is all about.”

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