The past year has seen dramatic shifts in new equity mandates and portfolios, with changes in manager selection patterns suggesting that searches for emerging market and Asia-focused equity managers have been a high priority among pension funds and other investors while US equity searches declined significantly. These are the key findings of a report released by market intelligence provider Bfinance.

According to the report, 'New Equity Perspectives - Emerging markets, ESG and the active/passive debate', smart beta contributed only 10% of new mandate activity in the past 12 months, with ESG becoming increasingly relevant beyond the traditional developed markets despite some criticism around performance.

ESG dimensions in the active/passive debate

There is an interesting current debate regarding the compatibility of ESG policies with the rise of passive management, according to the report which found a 'substantial and growing universe of passive indices and semi-passive products with an ESG dimension'. These range from tilts based on ESG ratings to specific themes such as the shift towards a low-carbon economy.

The report also notes increasingly specific and complex ESG requirements from pension funds, endowments and sovereign wealth fund (SWFs). Depending on these differing priorities, investors should be aware of the potential suitability and/or limitations of passive ESG, including aspects such as the reliance on externally sourced data and the approach to using an 'engagement' time budget.

The firm says investors should also ensure that risk/return expectations for passive ESG are clearly communicated to and understood by all stakeholders. 'For the most part, these strategies seek to replicate benchmark-type risks and returns,' it said. 'However, at the same time, publications are pointing towards outperformance of ESG indices, albeit over a short period of time, leading to claims about ESG factors and some blurring of the lines with the popular factor investing trend.'

The report also found that emerging markets, ESG and active vs. passive management are not just the three dominant equity themes of 2017 but they are also 'increasingly colliding, interacting and occasionally conflicting with one another'.

Structured products

The number of ESG indices used in the structured products market has rocketed over the last five years with issuers developing their own gauges or partnering with index providers. Most recently, HSBC teamed up with MSCI to develop the World Select SRI and Europe Select SRI Indices, which will be used by the UK bank to build a new range of structured products.

Other investment banks active in this segment include JP Morgan (JP Morgan Ethos Investments), Commerzbank (Solactive Global Ethical Low Volatility AR EUR Index), Deutsche Bank (partnership with Arabesque); BNP Paribas (FTSE low carbon series), Natixis (Euronext Climate Orientation Priority 50 Equal Weight Excess Return Index); Societe Generale (Finvex Ethical Efficient Europe 30 Price index).

A number of ESG indices developed by index providers have also been featured in structured products including the S&P Dow Jones Sustainability Europe Diversified High Beta High Dividend Index and S&P Europe 350 Climate Change LVHD Index; Stoxx's iStoxx Europe ESG Select 30 Index;  Finvex's ESG indices; Solactive's Solactive Global Ethical Low Volatility AR EUR Index and Ethical Europe Equity Index; as well as MSCI's ESG fixed income indices which were developed in collaboration with Barclays in 2012.

Regional breakdown

Headline trends and figures reveal that 28% of all new equity manager selection projects over the past 12 months were for emerging markets, an increase of over 100% on the previous year and, although 'Global Emerging Market' searches proved to be the most popular version, 'Emerging Asia' also received significant attention. Asia proved to be the most popular regional choice, with not just the emerging economies but Japan equity and broad Asia equity proving attractive. This is a stark contrast with the previous year, when Global Equity Mandates made up almost 40% of the total number of new equity mandates (now 24%) and the US dominated the regional picture.

The paper also highlights the cost of ESG integration, stating that it is not linked to notably higher fees in emerging market equity. Emerging market equity manager fees have shown resilience overall in 2017, with few dropping their prices, and the median fee quoted for all global emerging market searches in 2017 so far has been 69bps (pre-negotiation), while the median quoted fee for ESG-specific searches was just above 70bps, with other factors - such as mandate size and structure - having a more significant impact on fees.

Click in the link to read the 'New Equity Perspectives - Emerging markets, ESG and the active/passive debate' report.

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