Investors call for more innovative ESG funds

Fund selectors indicate where they would welcome more variety in product offerings

Investment managers have called for greater diversity in the sustainable funds that are being brought to market by providers, as research shows a lack of product innovation could be curbing ESG adoption.

A study carried out by Capital Group, surveying 1,130 global institutional and wholesale investors found that 40% said there is a lack of innovation in the products asset managers are launching, preventing investors from a greater take-up of ESG funds.

This is despite a considerable number of funds being launched; over the past two quarters to end of September 2022, 388 sustainable strategies were developed globally, according to data from Morningstar.

“As fund selectors, we have witnessed considerable growth in sustainable equity funds with a global tech and thematic focus, but fewer funds are venturing outside that space,” commented Phoebe Stone, LGT Wealth Management’s head of sustainable investment and intermediary services.

Stone added the team would welcome more funds providing exposure to geographies such as Japan and Asia, particularly those investing in companies delivering “solutions to sustainability challenges”.

Ben Yearsley, director at Fairview Investing, said there could be a case for more innovation around multi-asset or the traditional 60/40 funds, but added it is also needed in the passive space – the Capital Group study found 63% of investors prefer the active approach when selecting ESG funds.

Yearsley commented: “I’m amazed that only 63% of investors think active is the way to approach ESG investing.  I’ve yet to really see a passive ESG that ticks the boxes: one such ETF had two tobacco companies in the top ten.

“Therefore, the innovation will probably come from the passive sector, which is massively behind the curve on ESG funds in my view: mostly substandard currently. This obviously gives active managers a massive head start, which they should use wisely.”

The research also found 46% of global investors think there are not enough funds aligned to the United Nations Sustainable Development Goals (SDGs) and reported that existing funds that target the SDGs “overly focus on environmental issues”. Indicating further areas where they would like to see more products, 43% of the investors said there is a specific need for multi-thematic ESG funds.

Jessica Ground, global head of ESG at Capital Group, said the research showed investors currently have access a broad range of ESG themes but only through several single-thematic or narrowly focused funds that are currently available on the market: “The demand for more innovative ESG funds may reflect a desire to diversify their holdings as investors recognise they need all-weather solutions that can adapt to changing market conditions and better withstand volatility.”

Transitioning

The Capital Group study also found investors would like better offerings within the transition fund space as they recognise the decarbonisation of the economy cannot take place by supporting ESG leaders alone – Ground said investors are taking “a more sophisticated and holistic approach to ESG developing, as investors evolve away from negative screening and divestment”.

Four in 10 investors (40%) currently favour investing in a combination of companies that are ESG leaders and ESG transitioners, while a third (34%) stated asset managers investing solely with ESG leaders at the expense of transitioners are doing more harm than good.

Stone commented: “Our clients are increasingly asking us about this [transition], particularly in places like Asia where the transition is likely to happen with the most velocity. We have seen many fund houses improve their stewardship practices, however we would like to see increased demonstration and reporting around the outcomes their engagements are having on companies.”

Yearsley also noted the latest update on Sustainability Disclosure Requirements (SDR) from the Financial Conduct Authority (FCA) could spur further adoption of ESG funds, and included the label ‘sustainable improvers’ for products with “an objective to deliver measurable improvements in the sustainability profile of assets over time”.

“Those rules seem quite sensible and finally give some clarity about how funds should be labelled and what investors should expect,” he said.

However, Scott Spencer, investment manager at Columbia Threadneedle Multi-Manager, said the industry needs to go further in terms of education if we are to see further ESG integration.

“I think investor education remains the key to further adoption of ESG and sustainability. These two concepts (ESG and sustainability) are different, ESG is not about product labelling, it is about investor insight and a tool to enhance both risk and rewards,” he said.

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Natalie Kenway

Natalie is global head of ESG insight for ESG Clarity and has been an investment journalist for 16 years. She won Editor of the Year at the Aviva Investors Sustainability Media Awards 2021, and was Winner...