Not all RI funds are created equal
Looking for accountability in funds’ claims for responsible investment
It is time to raise the level of accountability in responsible investment (RI) funds. Not all RI funds are created equal, so it is worth looking at a fund’s RI approach, and the nature of its holdings to get a clearer picture.
Awareness of environmental, social, and governance (ESG) issues is continuously increasing in the investing community. This has led to a well-documented boom in RI assets under management (AUM) and a growing number of RI funds being offered by an increasing number of firms. The numbers can vary depending on the criteria for identifying RI funds, but the trends are real.
According to data from the Responsible Investment Association, the period from 2017 to 2019 saw a 36% increase in AUM among Canadian RI mutual funds while ETF assets in the RI category more than doubled over that time. In 2020, the number of RI mutual funds and ETFs available in Canada rose by 35%, and the number of firms offering RI mutual funds and/or ETFs rose to 29 from 16.
In the next five to 10 years I expect to see almost every mutual fund or ETF provider in Canada offering funds under the RI label. The motivating factors for launching these products are there. The primary reason, of course, should be to motivate companies across the world to improve across ESG factors, but RI funds will also improve a fund company’s image and provide a new vehicle for increasing AUM.
So this gives us even more reason to investigate RI funds’ holdings and which RI approach they employ. The longer we go without holding funds accountable, the more it is a disservice to responsible investing, detracting from the positive influence that the financial industry can have on the world. If we simply buy what we are being sold, we are not actually helping the planet in ESG factors; rather, we are just helping fund companies increase assets under management.
Fund XYZ is an example of a Canadian bond fund that is labeled as a responsible investment fund. (I will not identify this fund, because it is not fair to single it out at this point, as there are others like it.) The fund is labeled with the following RI strategies: shareholder engagement; negative screening; and ESG integration. The product exclusions include tobacco, nuclear energy, weapons/military, gambling, pornography.
But if you look through what this fund is holding, you might not agree.
First, shareholder engagement in bond funds is a debatable issue. In fact, “shareholder engagement” is impossible because bondholders are not shareholders, they do not have voting rights, and cannot submit shareholder proposals. But we can give them the benefit of the doubt and call it “corporate engagement,” because bondholders do have access to, and the opportunity to communicate with, management, especially if they are also shareholders in the same company. The effectiveness of these engagements is almost impossible to measure, but that is a topic for another time.
The second issue with this fund, is that it holds about 50% government bonds, so there is no corporate engagement there. Of the top 20 holdings in this fund, only five are corporate bonds. The other 15 are government bonds, so the opportunity for engagement is limited. This leads to a bigger question, and one I don’t have the answer for right now: How much of a fund’s portfolio should the fund company be engaging with in order to call it a “corporate engagement” fund?
The third issue is the product exclusions that are listed: tobacco; nuclear energy; weapons/military; gambling; pornography. The fund has significant holdings in Ontario government bonds, but the Ontario government owns Ontario Power Generation, which in turn owns two nuclear power stations that provide approximately 60% of Ontario’s power. The Government of Ontario also owns Ontario Lottery and Gaming Corp., which is responsible for Ontario’s lotteries, casinos, and horse-racing tracks. The fund also has significant holdings in Canadian government bonds. The Canadian government, of course, owns and operates Canada’s military.
Consequently, nuclear energy, weapons/military, and gambling should not be listed as exclusion in this fund.
This fund is no doubt an ESG integration fund, but to claim shareholder engagement is questionable, and the listed product exclusions are misleading. There are many examples of funds like this, that is, funds that are being presented as more than they are. The point is that if we simply rely on the labels that are presented, we might not have the positive impact we are intending across the ESG factors.
Still, there are examples of funds that invest exactly how they are presented, with such fund companies providing great transparency. NEI, for example, allows you to look up its proxy voting record and historical engagements by fund or by company. This provides great insight into NEI’s potential impacts and areas of specific companies they are trying to influence.
I am certainly not trying to discredit RI funds or the RI marketplace. In fact, it’s the exact opposite. RI funds can have a significant positive impact on how companies operate worldwide. But for that to happen, RI funds need to be held accountable. We need to exhaust data resources on these funds.
Despite all the apparent flaws in ESG scoring systems, there is a great value in them. They provide a necessary step in ensuring that a fund company is doing what it says it is doing. The fund companies that are transparent about their holdings and processes will be the ones driving real change.
Reid Baker, CERA, ASA, is Vice President, Analytics and Data, at Fundata Canada Inc., a leading source for investment fund information, and is Chairman of the Canadian Investment Funds Standards Committee (CIFSC).
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