The dual trends of passive investing and environmental, social, and governance (ESG) investing are converging, but integrating them remains a challenge, according to a new report from Cerulli Associates Inc.
The Boston-based consulting firm says that efforts to integrate ESG considerations with passive investing is “gathering momentum,” but that it also faces obstacles.
The Cerulli report states that, while investor demand for ESG indexes is expected to keep growing, “the risk is that they could fail to match the sustainability criteria investors believe they are buying.”
For example, the report states, passive ETFs “tend to use benchmarks offered by the major index providers, but they may have little predictive power.”
First, ESG-focused indexes curbed exposure to major polluters. Next, they focused on companies with large reserves of fossil fuels, the report states.
“Now, the emphasis is on increasing exposure to companies with revenues exposed to the ‘green economy’,” Cerulli says in ts report.
“However, climate risk and its potential impact on portfolios in the future is a complex matter,” Cerulli notes.
For example, it says, fund managers have different visions about ways of integrating ESG into low-cost, passive products. The report adds that there’s a finite capacity for managers to monitor the large number of companies contained in indexes. It also cites a lack of ESG standards and a shortage of meaningful forward-looking data.
“The successful integration of ESG into passive strategies will … ultimately depend on managers being able to enhance their stewardship of and their engagement with the thousands of companies they track,” Cerulli concludes.