Should institutional investors dedicate the time and effort required to create bespoke Responsible Investing (RI) or Environmental, Social, and Governance (ESG) portfolios to achieve their mandates, or is there a better solution? Mark Webster, Director, Institutional & Advisory ETF Distribution, traces the origins and evolution of RI, outlines the potential pitfalls for managers, and discusses the methodology behind BMO’s suite of ESG index ETFs.
Understanding ESG
Responsible investing started in the 1920s, when religious groups in the United States expressed their desire to invest their capital with companies that shared their principles. The notion was that investors could allocate their money to companies whose principles and practices met or conformed with specific values. Shortly thereafter, when the U.S. was struggling through the Great Depression, people developed the concept that companies should be good corporate citizens, measured on the basis of their operation’s impact on society as a whole. Both these phases spawned what came to be referred to as Socially Responsible Investing.
Regardless of definition—be it Responsible Investing, Sustainability, or ESG—the data set at hand is enormous. Several large plans have decided to become U.N. Principles for Responsible Investing (PRI) signatories to demonstrate their bona fides. But unless there are tremendous resources at hand, maintaining UN PRI signatory status may impose a significant reporting burden. Should they be poorly rated, there may also be significant reputational risk.
Some pension plans in Canada have created internal capabilities to manage ESG but smaller ones have delegated responsibilities in this realm to their asset managers.
The problem and the solution
The MSCI ESG Leaders approach
As an asset manager, we, like the largest pension plans in the world, are a universal owner, meaning that we own a portion of the entire market or economy. As such, we performed extensive due diligence before deciding on an approach to provide to our clients. We had to answer a fundamental question when deciding how to define our solution: What were we trying to solve and for whom?
Individuals may choose to tilt their exposure to reflect whatever values or outcomes they deem appropriate, but institutions—be they pensions, endowments, or discretionary investment counsellors—are governed by their fiduciary duty and therefore must tread very carefully.
First and foremost, being an index, the methodology is explicit and consistent, ensuring uniformity across regions and asset classes. In addition, there are specific exclusions on controversial business practices, not on industries or sectors. The objective in identifying specific exclusions is to uphold the fiduciary risk management concept which underpins the ESG approach:
Criteria | Scale / consideration | Deciding factors |
|---|---|---|
Selection universe | MSCI Global IMI | |
ESG rating over BB | AAA – CCC | Companies rated B or CCC are ineligible for inclusion (unclear what would happen if required for market cap) |
Controversy score over 3 | 0 – 10
| Green / yellow / orange / red coding (red = below 3); incorporated into BMO ESG Report Card
|
Ranking criteria: | ESG Score
| |
ESG Trend (12 months) | If two companies have an identical score, Index will favour the company with a better ESG trend | |
Existing Index Participants Favoured
| If two companies have the same ESG score and the same ESG trend, existing index participant favoured
| |
if ESG Score & ESG trend identical among existing Index participants, higher market cap company is favoured | ||
Marginal companies included if it is necessary to meet 50% capitalization requirement | ||
Exclusions: | Alcohol | Producer earning 50% of revenue or over $1 billion in revenue |
Gambling | Producer earning 50% of revenue or over $1 billion in revenue | |
Tobacco | Producer earning 50% of revenue or over $1 billion in revenue | |
Nuclear power | Companies with over 6,000 mega watts capacity or over 50% capacity from nuclear sources / companies involved in enriching nuclear fuel / companies involved in uranium mining / companies involved in nuclear plant design or construction | |
Conventional weaponry | Companies earning 50% of revenues or over $3 billion in revenues | |
Nuclear weaponry | All companies manufacturing systems or components | |
Controversial weaponry | All companies involved in manufacture of landmines, cluster bombs, uranium weapons, blinding lasers, biological or chemical weapons | |
Civilian firearms | Companies earning 50% or more than $100 million in revenues | |
Unconventional energy | Thermal coal, shale oil, shale gas, oil sands, coal bed methane and coal seam gas | |
Conventional energy | Arctic onshore or offshore, deep water, shallow water or on/offshore
|
Conclusion
There is greater regulatory scrutiny on RI, Sustainability, and ESG everywhere. Due to Canada’s numerous regulatory bodies, there continues to be debate on how they should be governed. Institutional investors should take great care when implementing these types of strategies, being mindful of the compliance and operational strain customization could pose. Educating stakeholders about fiduciary constraints, while providing a thorough and measurable solution through inexpensive and scalable ESG ETFs can create a coherent foundation to meet mandate requirements while maintaining fiduciary duty.
For those interested, the BMO ETF ESG Report Card provides comprehensive reporting on the exposure and on the stewardship reinforcing the holdings.
To learn more about BMO’s suite of ESG ETFs or receive other trading insights, please contact your BMO Institutional Sales Partner.
Sources
Disclaimers
Any statement that necessarily depends on future events may be a forward-looking statement. Forward-looking statements are not guarantees of performance. They involve risks, uncertainties and assumptions. Although such statements are based on assumptions that are believed to be reasonable, there can be no assurance that actual results will not differ materially from expectations. Investors are cautioned not to rely unduly on any forward-looking statements. In connection with any forward-looking statements, investors should carefully consider the areas of risk described in the most recent prospectus.
The viewpoints expressed by the authors represents their assessment of the markets at the time of publication. Those views are subject to change without notice at any time without any kind of notice. The information provided herein does not constitute a solicitation of an offer to buy, or an offer to sell securities nor should the information be relied upon as investment advice. Past performance is no guarantee of future results. The statistics in this update are based on information believed to be reliable but not guaranteed.
This article is for information purposes. The information contained herein is not, and should not be construed as, investment, tax or legal advice to any party. Particular investments and/or trading strategies should be evaluated relative to the individual’s investment objectives and professional advice should be obtained with respect to any circumstance.
This article may contain links to other sites that BMO Global Asset Management does not own or operate.
Any content from or links to a third-party website are not reviewed or endorsed by us. You use any external websites or third-party content at your own risk. Accordingly, we disclaim any responsibility for them.
Commissions, management fees and expenses all may be associated with investments in exchange traded funds. Please read the ETF Facts or prospectus of the BMO ETFs before investing. Exchange traded funds are not guaranteed, their values change frequently and past performance may not be repeated.
For a summary of the risks of an investment in the BMO ETFs, please see the specific risks set out in the BMO ETF’s prospectus. BMO ETFs trade like stocks, fluctuate in market value and may trade at a discount to their net asset value, which may increase the risk of loss. Distributions are not guaranteed and are subject to change and/or elimination.
BMO ETFs are managed by BMO Asset Management Inc., which is an investment fund manager and a portfolio manager, and a separate legal entity from Bank of Montreal.
BMO Global Asset Management is a brand name under which BMO Asset Management Inc. and BMO Investments Inc. operate.
“BMO (M-bar roundel symbol)” is a registered trademark of Bank of Montreal, used under licence.
