ESG Fund Sponsors are Reacting to Increased Scrutiny
Cautious exchange-traded fund (ETF) sponsors are creating a smokescreen to avoid trouble for themselves.
Environmental, Social, and Governance (ESG) investing works best with openness and transparency. Until now, ETF and mutual fund managers have shown themselves eager to share their ESG guidelines and how the underlying investments fit. After all, achieving and maintaining a designation that allows your fund to grab a chunk of the $2.5 trillion category is good business. Pending regulations which could impact the underlying investments and fund’s ESG status’ have caused fund managers to exercise more caution than they have in the past when sharing information.
ESG Fund Survey
Sage Advisory is a $16.5 billion financial advisor serving clients that choose ESG as a theme for their investments. In each of the past four years, Sage has surveyed fund managers to produce their Stewardsip Report. The 2002 report was released today.
ETF providers that responded to the survey offered much less manager disclosure and transparency about their environmental, social, and governance activities compared with the previous year’s responses. According to the report, there was also a distinct change in tone. The advisory group wrote in its report, this is likely because of pending regulation in Europe and from the U.S. Securities and Exchange Commission that would more clearly define ESG investments. If something the fund manager is doing changes its category, the fund manager would prefer to know and take action before investors find out through a third party.
“There was a noticeable difference in terms of reading the responses, and seeing the restrained language, almost kind of a legalese language to the responses that had not been there in the past,” said Emma Harper, senior research analyst for ESG risk management at Sage Advisory who compiled the survey.
About the Survey
The ESG survey has 69 questions and covers seven areas of stewardship, including proxy voting, climate, and governance. Sage sent surveys to 34 ETF providers and received responses from 23 issuers, including seven of the ten largest ETFs in the U.S. by AUM. Including non-ESG assets, the respondents combined AUM is about $37.5 trillion.
Ms. Harper said, “It was almost by-the-book in the way they are explaining things, rather than all the flourishing details and pretty pictures of the things they can do.”
Harper said it was harder to get responses regarding proxy voting, specifically the number of times they voted against management. Large ETF providers have always tended to vote with company management and against shareholder proposals.
“Across the board this year, we had a number of providers saying ‘that’s confidential,’ or ‘here’s our voting record in general; go find that percentage for yourself.’ It wasn’t an easy straight answer for a number of them,” Harper said.
Regulators
Some asset management firms are thought by government watchdogs to be overstating ESG credentials. This suspected “greenwashing” could cause huge outflows if proven. Worse yet, regulators have been acting on concerns. German officials raided Deutsche Bank’s DWS unit over greenwashing claims, and the SEC fined BNY Mellon $1.5 million over misstatements about ESG for some mutual funds.
With one in three dollars in U.S. fund investments said to follow ESG industry rankings, the SEC’s fraud radar has been turned up, and they are investigating. The Commission is also proposing stronger disclosures and reporting, and wants to assure that a funds label accurately reflects its management style.
Currently, there are no standards that define ESG, just as there are no standards that define styles such as growth or value.
Take Away
In its report, Sage said it believes the proposed regulations and fines “has both positive and negative consequences.” Without a clear definition, investors will become frustrated and may find the sector less attractive. As greenwashing becomes more difficult and investors are better able to judge the fund’s purpose, investors can better understand the underlying assets.
ESG funds and ESG investing became a big thing during the pandemic era investment craze. It was a sector that had high returns that fed on themselves as more investors chased its snowballing momentum. It now constitutes one out of every three dollars in a fund. As the sector ages and regulators require better definitions, the growth of funds may be hampered by a lack of available investments. Alternatively, the appetite for these funds may decline as other investment “fads” take its place.
Managing Editor, Channelchek
Sources
https://www.sageadvisory.com/Form-ADV-Part-2A.pdf
https://www.sageadvisory.com/perspectives/2022-annual-etf-stewardship-report/