Are passive investors serious about social responsibility?

Published 27th November 2020 by Charlotte Moore

The fourth in our series of articles on responsible investment.

With more than $10tn invested in index funds, it is increasingly important for passive managers to take responsible investing seriously. But are these players allocating sufficient resource to the task and communicating their strategy clearly to customers?

It’s only recently passive managers have wanted to talk to a journalist like me about how they invest responsibly. The size of the assets managed by these companies make it increasingly important, however, that these firms take these duties seriously. According to the FT, earlier this year the assets managed by global index funds smashed through the $10tn level.

A passive manager is much more constrained than a traditional active manager. A firm managing, for example, a concentrated portfolio can exclude certain stocks, select those stocks with strong environmental, social and governance characteristics as well as engage with firms to improve corporate behaviour. In other words, they can deploy the full continuum of responsible investing criteria.

But if you are providing an exchange-traded fund which tracks the MSCI World Index, responsible investing has very different connotations. It’s harder to make exclusions and impossible to make selections when your product is judged on how closely it tracks its benchmark. Acting as a responsible investor in these circumstances involves working hard to engage with companies to improve corporate behaviour.

That is far from straightforward. The MSCI World is composed of 1,603 stocks so an effective engagement program means keeping track of key issues at all these companies and deciding how best to engage with these firms to encourage them to improve, for example, their labour policies or environmental practices.

The scale of the task – and the amount of resource it requires to do well such as teams of analysts around the globe – mean that many of the larger passive managers talk a good game about responsible investing but fail to follow through.

Yet that’s no longer good enough: the owners of these assets want their investments to create a better society.

Differentiate and communicate

Demonstrating you take your corporate social responsibilities seriously will be a way for manufacturers to make their cheap commodity product stand out from the crowd – whether selling to an institutional or retail market.

That requires a strong communications strategy as well as a well-thought engagement process. It requires explaining how the company defines its responsible investing strategy and the processes involved. Firms need to keep track of their engagement programs so they force companies into action rather than endless conversations.

Often the most effective way to achieve change is to work with other large shareholders – Climate Action 100+ has been highly effective at getting oil and gas majors to adopt net carbon zero targets and large passive managers have been instrumental at making those changes.

Passive managers need to step out of their comfort zone and be prepared to campaign with others, monitoring and communicating clearly with all stakeholders about why they have taking these steps to change behaviour and reporting their failures along with their successes.

At a time when the industry needs to be talking more, why not talk to us? Email info@thescalepartnership.com