Smart beta managers to add more ESG analysis

The group surveyed came from a wide variety of organizations, the report said, including government groups, corporations and private businesses, and non-profit organizations and universities.

Climate change and carbon-related issues are top of mind for asset owners, the report said, with 64% of those surveyed saying they wanted to address these risks in their smart beta strategies. Close behind were broader environmental themes — such as resource use and pollution — at 59%, followed by governance and social themes (e.g., human rights supply chain standards) at 55% each.

In contrast, asset owners were less interested in negative screening or divestment, which the report attributed to “a growth in the more sophisticated approach of re-weighting based on ESG/sustainability criteria.”

Rather than block investments from smart beta portfolios entirely, asset owners would prefer to re-weight or tilt allocations based on ESG criteria. These would be applied alongside traditional smart beta factors that are focused on achieving better risk-adjusted returns through rules-based — and largely passive — weighting selection.

When it comes to securities selection and sustainable investment, equities continued to be the most popular asset class for those surveyed, with 85% applying ESG analysis in that area. That was followed by fixed income (58%) and multi-asset (31%).

A recent report from Morningstar, which was focused on Canada, also noted that equities are the main area where sustainable strategies are implemented. That report indicated that more than half of ESG funds outperformed their peers in the second quarter and that, as of June 30, assets invested in such funds hit $8.8 billion (excluding investments in fund of funds), up 13% from the prior year’s end.

Between now and 2022, the FTSE Russell report said, interest in smart beta ESG analysis incorporation is likely to grow. Only 12% of respondents said they don’t expect to increase their use of sustainable investment, though 42% were undecided.

FTSE Russell said overall that sustainable investment and the incorporation of ESG factors “has become mainstream.” Further, the report said, regional differences in the use of ESG factors seemed to be “levelling off.”

Interest in ESG smart beta investing continues to be most prevalent in Europe, the Middle East and Africa (EMEA), where more than 80% (up from 73% in 2019) of those surveyed said they want to incorporate smart beta ESG analysis. In North America, the result was lower at 42% of respondents, but that’s a steep rise from 17% a year ago.

FTSE Russell said in a release, “Fixed income applications of sustainable investment considerations, which have historically trailed the equity market, are particularly strong in EMEA where 75% of respondents are currently implementing or evaluating sustainability considerations for this asset class, compared with 45% in North America.”

This is the fourth year for this report. And according to FTSE Russell’s head of sustainable investment data and methodologies, Jaakko Kooroshy, interest in sustainable strategies has grown over the past four years.

He said in the release, “In 2020, we have noted a significant uptick among asset owners worldwide interested in applying sustainability considerations to their smart beta strategies—what we call Smart Sustainability.”

David Harris, group head of sustainable business for the London Stock Exchange Group, added that 2020 has so far been shaped by factors such as the pandemic and social justice movements, “leading asset owners to re-evaluate investment strategies and priorities.”