Environmental, social and governance (ESG) indexes might be a big focus in continental Europe but they are a lot less so in the American market, according to panellists during the Indexing: Trends and Challenges discussion at the 7th SRP Americas Conference on May 24 in Chicago.
"In the US ESG is been talked about a lot but we have seen almost zero trades being done," said Rahul Saito (pictured), director of sales, North America, Stoxx. "Someone once said that feeling good doesn't make money."
ESG is a bit of a bad word, according to Andre Corpuz, managing director, Vets Indexes. "Certainly in the retail space people have the general consciences that ESG underperforms, and it doesn't as a rule."
Edward Allen, managing director, head of index client coverage, North America, MSCI, believes that there is a complete misperception of ESG returns. "It's kind of like low risk has to equal low return but in the past five years we have seen that is actually the opposite," said Allen. MSCI has got the largest group of independent ESG researchers in the market, according to Allen, but the company does not think about ESG from an environmental, or feel good point of view. "We just don't care. We want to provide research for asset managers, or for structurers, to provide better financial outcomes, by using ESG data in portfolio construction," said Allen.
Most people end up focusing on governance when they are looking at ESG as a whole, according to Corpuz. "The G portion of the portfolio really dictates the E and the S portion," he said.
According to Saito, ESG should really be a filter. "You can easily have an ESG strategy running in part of your portfolio and then have the other part of your portfolio filled up with cluster bombs and whatever," said Saito noting that it would be much easier to have some sort of screening going through the entire portfolio. "In that case ESG is merely a filter and on top of that you are building factor strategies, as opposed to ESG being a strategy.".
Allen said he would not recommend impact, "because with impact you probably will give up some financial return in order to get a positive impact whether that is through micro finance, providing nutritious foods for developing countries, education, etcetera".
"There are a lot of good things and we feel good about it, it appeals to millennials and the younger generation, but if you talk to some of the big fiduciary pension plans, who have the responsibility to provide the best return, regardless what they invest in, they are still not comfortable yet that they can make that decision, and that's why some of the investment in ESG hasn't happened in the States," said Allen.
Factor based indexes, also referred to as smart beta, is a trend which is still making waves in the market with Stoxx recently launching an AI index, according to Saito. "It is a big spectrum," said Saito. "We are talking to ETF providers, we are talking to UIT providers, and we are also talking to structured products providers. There are different iterations of it. Let's say, if you pick AI, it can be a theme, but the way you would approach the index itself could be quite different depending on what kind of wrapper it goes in."
According to Corpuz, there has also been a growing increase in fixed income in the last couple of years. "I think fixed income has lacked the equity market in terms of indices," said Corpuz.
When MSCI split from Morgan Stanley back in 2007 it took the equity index business, according to Allen. "But Morgan Stanley, like most banks, also had a fixed income business and they said if you want to split, cool, but you have to take this fixed income business with you," said Allen. "We did, and within six months we shut it down because we found very quickly it's really difficult to prize bonds if you don't have a fixed income trading desk. It's very expensive, and that is why the creators of fixed income indexes are mostly banks."
However, since the move to passive has occurred a lot of that has changed, said Allen. "We have seen a tremendous amount of M&A in the fixed income index space: Barclays going to Bloomberg, FTSE Russell picking up Citi. People are now really looking to revolutionise what fixed income indexes can do because all the development has been on the equity side of the business," said Allen who admitted that MSCI is now looking very closely at fixed income. "I think what we will not do is jump in the market and compete with the Barclays' out there, that would be a sucker's game and a bad trade. My personal opinion is that if we were to come to the market it would be with some factor based strategy on fixed income and then license it either to be the basis of a structured product or an ETF."
Although Stoxx is predominately an equity index provider, the company has been peeping into the opportunity of fixed income for a good three years now, according to Saito. "Acquisition is obviously the way to do it," said Saito. "The other way is to build it internally and we have just started doing that. Our ultimate goal would be a multi-asset class index offering that could go through both the equity and the fixed income space."
One of the big challenges of fixed income is pricing, according to Corpuz. "Equity indexes are easy. You got one or two equities and boom you pop them in, but with bonds you have got all kinds of dimensions," said Corpuz.
"If you are talking about equities you have two share classes at max," agreed Saito. "Whereas if you go into fixed income, first of all you have to look at the credit, then you have to look at the different layers of bonds, which not all of them have got liquidity," said Saito. "How to pick that, how to choose it, how you price it, becomes a much more complicated game than in equities," he said.
"That's where the struggle is and I don't think no one has cracked the code but nevertheless I think that is the direction we are going, multi-asset," Saito concluded.
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