Choosing the right vehicle for ESG

Thursday, October 1, 2020 | By Noah Levin, Strategic Business Consultant Advisor

Choosing the right vehicle for ESG

In the current landscape, asset managers must differentiate their offering or risk losing sales, market share or product placement. Whether it be new product structures or investment strategies, firms continuously innovate from a product development perspective to discover, demonstrate and defend their differentiators, whether those differentiators are performance, price, process or personalization.

During the past five years, Environmental, Social and Governance (ESG) investments have been an attractive segment for almost any manager looking to set themselves apart from competitors, diversify sales or fill out product lineup. The combination of increasing investor demand, muddled regulation and education, and low barriers to entry enabled new funds and participants to proliferate at never-before-seen rates. Looking at the list of strategies in Morningstar's ESG universe in recent years illustrates how rabid product development has been and just how crowded traditional markets have become. As of September 1, 2020, there were 1,191 ESG-classified funds still trading in Morningstar's domestic ETF and open-end fund universe, with 195 having already closed. In this universe, there have been 1,386 ESG-classified fund launches, with 587 (42%) since the end of 2010, 342 (25%) since the end of 2015 and 140 (10%) since the end of 2018.

We believe that too many firms have jumped on the ESG bandwagon without considering all the dynamics of operating in this space. Determining the right structure is as critical to a firm's success in ESG as determining the right investment approach and criteria; however, structure selection's importance has grown as low-cost ETFs now dominate traditional ESG flows, and a core differentiator is no longer available to many new entrants.

In our most recent “Productivity Insights – Product Strategy & Management Team” survey, we asked individuals responsible for product strategy and management teams at asset managers to rank their top five product launch priorities over the coming year, and we compared those answers to our 2019 survey and found several priorities gaining momentum:

  • "ESG strategies" was the most common product launch priority for the second consecutive year
  • "Single strategy SMA" experienced the largest uptick, up 27% from 2019
  • There was a clear distinction among firms when delineating by size: firms with >$100B in AUM placed more emphasis on "ESG strategies" and "Multi-asset model portfolios" while "Single strategy SMA" received more emphasis from firms with <$25B in AUM

Graph shows product launch priorities in 2019 vs 2020

These priorities will increasingly direct product strategies moving forward, and it is at the convergence of these priorities where we see a significant opportunity. The managed account market has experienced a revival in recent years as investors seek greater customization in their portfolios. Within this market, SMAs are projected to represent the largest opportunity and are likely to be the most adopted ESG strategies by RIAs moving forward.  ESG delivered in model portfolio and SMA wrappers can provide benefits to investors and advisors which traditional investments cannot. These inherently aligned benefits center around customization:

  • SMAs can be brought to market more easily and quickly than mutual funds
  • A significant aspect of the SMA business relates to the ability to execute customizations which reflect client-specified ESG considerations
  • SMAs provide clients the ability to depart from a cookie cutter ESG portfolio by identifying individual securities it may want to include or exclude
  • Overlay managers have the ability to run tax management strategies on multiple SMAs, which makes the structure attractive for high-net-worth clients, a demographic driving growth within the ESG market
  • Advisors can create a suite of model ESG portfolios for the majority of their clients seeking ESG exposure while reserving true customization for a select group that are passionate about specific issues or care deeply about aligning their investments with their own unique set of values

Multiple managers and distributors have already begun to leverage technology and the unique characteristics of non-traditional investments to deliver customized ESG portfolios. Recent developments from managers and distributors highlighting the convergence of these trends include:

  • Bank of America Merrill is expanding its third-party CIO model program by adding eight managers, with third-party ESG models to be announced in the next several months
  • Russell Investments partnered with Vestmark to launch tax-managed separate accounts with plans to expand its offering to include further custom overlays, such as factor exposures and ESG considerations
  • Calvert Research and Management partnered with Parametric Portfolio Associates to launch ESG equity separate account strategies that are fully customizable and have tax-loss harvesting benefits
  • Fidelity Investments partnered with Ethic to offer advisors a way to create personalized ESG portfolios for their clients and execute them as separately managed accounts
  • Schwab acquired Motif’s technology and intellectual property, a robo-advisor known for their ESG portfolios, to develop thematic and direct-indexing offerings for its retail and RIA clients

ESG investments will be increasingly required to meet the diverse and expanding needs of a diverse and expanding population of investors, which is why personalized portfolios (i.e. model portfolios and SMAs) are a natural fit for ESG investing, and enable managers and advisors to create bespoke solutions and analyze holdings for the most important ESG factors.

SS&C’s Research, Analytics, and Consulting team can help asset managers navigate the ESG waters to target the best opportunities and optimize their distribution efforts. To learn more, read about our consulting capabilities or some of our data-driven research.

Research, Analytics, and Consulting

Theme picker