With increasing indication that ESG is going conventional, Dirk Söhnholz, CEO Diversifikator GmbH discusses what this means for equity investments going ahead.
How do you ensure an equity fund meets responsible investment criteria?
We only use passive investment funds and direct equities. The fund selection starts with the relevant index. The stricter the responsible index, the better. Therefore, we prefer concentrated indices and funds. Unfortunately, even the strictest responsible indices for which investment funds are available, often tolerate sales in "excluded" market segments and do not use separate ratings for E, S and G. Thus, good governance can compensate bad ecological or social ratings.
How do you ensure a commodity fund meets investment criteria?
We only use passive commodity funds. We prefer commodity-stock indices to commodity derivative-indices, but such stock indices are not available for all commodity market segments. Controlling mainly focusses on tracking difference with the respective index, meaning that low-cost funds are usually preferred.
Will certain existing equity and/or commodity funds face headwinds in future depending on ESG/sustainability regulatory developments?
Commodity funds are already under significant pressure since many, even large investors who want to invest in a responsible way, do not like commodity investments. That is especially true for funds focussing on derivatives. Regulators in this case tend to follow large investors.
We expect funds in general, including commodity funds, to focus more on "responsible" components in the future. Future regulation will hopefully bring more transparency and thus increase the pressure on funds to become more "responsible", howsoever defined.
Will certain existing equity and/or commodity funds face headwinds in future depending on shifts in investor demand related to, say, decarbonisation/climate change responses?
Absolutely. Commodity funds may be shunned altogether by responsible investors. With two funds being otherwise similar, the more responsible one will have a much higher likelihood of being selected.
Do you see an opening for new types of equity and/or commodity funds to meet new investor demand for, say, carbon neutral funds, or funds that promote solutions to the UN Social Development Goals?
Certainly, but I am sceptical about equity or commodity funds trying to focus on impact or UN SDGs. Public equities focus on profits first. Current public equity offerings with the labels impact or SDG often include stocks which no serious investors would classify as classical impact investments. The MSCI Impact Index for example includes Danone and Procter and Gamble. Greenwashing-attempts are a serious issue.
I see many opportunities for equity funds applying strict responsibility criteria across any investment universe. In Germany, investors can chose from almost 2000 ETFs- Less than 100 can be considered as "responsible".
As soon as investors understand that responsible investing does not require compromising performance, they should invest only in responsible ETFs or low-cost portfolios. That would lead to a surge in new responsible investments. In addition, we expect direct ESG indexing offers as alternatives to ETFs and active funds.
Is it easier to launch new equity and/or commodity funds that incorporate ESG factors embedded in the investment process, rather than change the investment process of existing bond funds?
The investment process of existing funds technically can be changed easily. Managers just have to use ESG as their first selection filter. The problem is, that most of them want to have low tracking errors to traditional indices and they do not want to change their investment processes. Also, they do not want to have major shifts in their portfolios.