ESG investing is dying. That’s not a bad thing
A version of this story first appeared in CNN Business’ Before the Bell newsletter. Not a subscriber? You can sign up right here. You can listen to an audio version of the newsletter by clicking the same link.
Environmental, social, and governance-focused funds, which were once deemed the darlings of Wall Street, may be on the way out.
They’re currently weathering a “perfect storm of negative sentiment,” said Robert Jenkins, head of global research at Lipper, a financial data provider.
Despite the gloomy forecast, Jenkins remains optimistic. He sees this as a natural phase of the market’s evolution. A new, more efficient system is taking shape that incorporates ESG standards into the bedrock of stock valuations, he said.
ESG investing as a separate entity could be on its way out, but the approach was wrong to begin with, said Jenkins. Instead, it should be integrated into the fundamental analysis of every investor.
What’s happening: Total assets under management in ESG funds fell by about $163.2 billion globally during the first quarter of 2023 from the year before, according to data shared exclusively with CNN by Lipper.
In March alone, total assets under management in the responsible investments fund market fell by $6.8 billion.
It’s not that the funds are underperforming, either. The average overall return for these funds was 2.2% in March — outperforming the 12-month moving average return for the wider market by 2.8 percentage points.
Instead, a confluence of political, geopolitical and market events has severely damaged interest in ESG investing.
Russia’s ongoing war in Ukraine forced traders to reconsider investing in energy and weapons stocks. Increased scrutiny also played into political differences around ESG investing and opened the door to vocal critics.
Because of a partisan divide, about half the states in the United States are enacting provisions to block efforts to invest in state-run investment accounts with an ESG lens, Lipper found.
Responsible investing funds also came up against mighty economic headwinds last year. These funds’ outsized investments in tech stocks and lack of energy stocks (which was the only positive sector in 2022), led to noticeable losses last year.
Things aren’t good.
Breaking the trend: “I think ESG was overly trendy and it got caught up in itself,” said Jenkins. “I was going to conferences two to three years ago, and I remember walking out and thinking ‘these guys aren’t saying anything new or different. They’re all saying the same thing.’”
Companies jumped on to the bandwagon and greenwashing, a marketing tactic to appear environmentally conscious in investments, became prevalent. That, in turn, hurt the movement’s reputation.
Jenkins sees what’s happening now as a winnowing of the responsible investing sphere. That’s all part of the maturation process, he said. “As data and disclosures move towards more standardization, ratings and analytics adjust for biases and become more transparent and aligned,” he said.
ESG won’t be as glamorous as it was before, but it won’t be a politically explosive term either.
“It’s actually going to fade a little bit from its marquee nature, it’s just going to be a part of sound business strategy and management,” said Jenkins. “They’re just going to be put alongside all the other fundamental analytics that we’re so used to hearing about, your earnings-per-share and your GAAP accounting. ESG ratings will just become part of that toolkit for investment managers.”
Can ChatGPT comprehend Fed speak?
The Federal Reserve has a language of its own filled with seemingly innocuous terms like “entrenched” or “data-dependent” or “gradual normalization” that actually hold enough power to turn the market on its head.
“Fed speak” refers to that purposefully ambiguous language used by officials at the central bank to communicate monetary policy decisions (in theory it’s used to avoid causing market volatility). Many reporters and analysts have made careers out of quickly deciphering that nuanced communication for investors and other interested parties.
But we may soon be out of work: A new research paper from Fed economists has found that ChatGPT and similar AI engines can do the job just fine. “The performance of GPT models surpasses that of other popular classification methods,” the paper found. “GPT models have the ability to explain why a certain sentence was labeled in a certain way” they found.
Humans remain at the helm for now — ChatGPT isn’t going to ask questions of Fed Chair Jerome Powell at his press conferences just yet. But, the Fed researchers wrote, these tools can be highly valuable “for assisting researchers and analysts in this domain.”
Mortgage rates rise again
Mortgage rates rose for the second week in a row, after easing inflation helped rates fall for five consecutive weeks prior to last week’s rise.
But that doesn’t mean that trend of increases will continue, reports my colleague Anna Bahney.
The 30-year fixed-rate mortgage averaged 6.4% in the week ending April 27, a slight increase from 6.4% the week before, Freddie Mac data show. The 30-year fixed-rate was 5.1% a year ago.
Despite the uptick, economists expect mortgage rates to decline this year as the rate of inflation decelerates.
Mortgage rates tend to track the yield on 10-year Treasury bonds. In other words, while the Federal Reserve doesn’t actually determine interest rates on mortgages, its rate hike decisions, investors’ reactions to them and Wall Street’s predictions of what could happen have an impact on mortgage rates.
The Fed is set to meet next week. Analysts expect the bank to raise rates by a quarter point and pause and even cut rates later this year.
GM, POSCO Future M to boost investment at battery materials plant in Canada – The Globe and Mail
General Motors Co GM-N and South Korea’s POSCO Future M said on Friday they will invest more to boost production at their chemical battery materials facility in Canada, taking their estimated total investment in the plant to over $1-billion.
The companies said the new investment includes an additional CAM and a precursor facility for local on-site processing of critical minerals.
The development comes a few days after the Canada’s federal government and the Quebec province each provided about C$150-million ($112-million) for the facility.
The companies last year established Ultium CAM joint venture, which is majority owned by POSCO Future M, and had initially invested about $327-million, according to media reports.
Their battery facility in Becancour, Quebec, will produce cathode active material (CAM) for electric vehicle (EV) batteries.
Canadian pension fund CDPQ puts brakes on China investment, Financial Times reports – Reuters
June 1 (Reuters) – Canada’s second-largest pension fund Caisse de dépôt et placement du Québec (CDPQ) has stopped making private deals in China and will close its Shanghai office this year, the Financial Times reported on Thursday, citing people familiar with the matter.
The news follows a May 8 parliamentary hearing in which several Canadian pensions, including CDPQ, were asked about their relationship with China as bilateral political tensions have intensified.
CDPQ is leading its regional investment efforts from Singapore, the report said, noting that it still has business interests in China.
“We paused private investments for some time already — and have focused on liquid markets, which is the majority of our two per cent total portfolio exposure to China. We expect this trend to continue,” the newspaper quoted CDPQ as saying in a statement.
CDPQ confirmed the Shanghai office closure later this year, but declined to comment further.
The Financial Times in February reported that Singapore’s sovereign wealth fund GIC has reduced private investments in China.
During the May hearing, Michel Leduc, a senior manager at the Canada Pension Plan Investment Board (CPPIB), said China was an “important source” for its portfolio.
“We recognize that any investment in China needs to be handled with care, sophistication, and an acute understanding of the current political and geopolitical environment,” Leduc said.
A CPPIB spokesperson declined to comment further on Thursday.
In May, Canada’s C$211.1 billion ($157.87 billion) British Columbia Investment Management Corporation (BCI) said it had reduced exposure in China and Hong Kong by about 15% over two years and paused direct investments in China.
“Our current exposure in China is less than 5% of the overall BCI portfolio, the majority of which is through public markets and via indexed funds,” the asset manager said.
In April Canada’s third largest pension fund, Ontario Teachers’ Pension Plan (OTPP), also closed its China public equity investment team based in Hong Kong.
At the start of the year, OTPP said it was pausing future direct investments in private assets in China, citing geopolitical risk as a factor.
OTPP expects to name a new head of Asia-Pacific Private Capital Direct in the coming months to replace Raju Ruparelia who has left to pursue other opportunities, a spokesperson said by email.
($1 = 1.3372 Canadian dollars)
Our Standards: The Thomson Reuters Trust Principles.
Why Canada would benefit from 'direct index' investing – The Globe and Mail
Traditionally reserved for institutions and ultra-high net worth individuals, direct indexing is a hot topic for investors as technology advances and downward pressure on retail trading commissions have done much to democratize its access. In the United States, direct indexing strategies are expected to outpace the growth of both ETFs and mutual funds. In response, U.S.-based providers are scrambling to build, buy or partner to acquire the required capabilities to get in on the action, driving down the costs and required account minimums for investors. For Canadians, it’s worth getting a better understanding on what Direct Indexing is, and what we can expect for the future of these strategies north of the border.
As a brief overview, direct indexing amounts to personalization at scale. Similar to a traditional investment fund, direct indexing gives individual investors a way to get exposure to a broad segment of the investment market, such as an equity index. Unlike traditional funds, however, direct indexing involves individuals investing directly in the underlying securities (stocks or bonds that make up a larger index), instead of simply buying units of a fund. Investing in this way offers multiple benefits. First, there are a variety of tax strategies (most notably tax loss harvesting) made available by directly holding the individual securities, which can add a potential 1-3% after-tax return on an annual basis. Second, the investor would have near-full autonomy to incorporate their personal preferences for the purpose of excluding securities that do not align with their values or investment objectives. Consider an index that is made up of the 500 largest companies listed in the United States, when investing in this product the investor does not have the choice of what companies make up this portfolio, meaning they may be required to invest in companies that do not align with their values or investment objectives. However, by holding the underlying securities, these non-aligned stocks can be excluded from the investor’s portfolio. While traditional thematic ETFs and mutual funds provide generic options for investor choice, the opportunities for hyper-personalization inherent in direct indexing strategies are almost endless.
As a concept, direct indexing is not new. Sophisticated investors, such as institutions and wealthy investors, have long held the requisite buying power and influence to overlay all manners of unique constraints on their investment portfolios. However, technology advances that could handle significant scale coupled with reduced trading costs brought this concept into the hands of individual investors – the former made it possible for investment managers to offer direct indexing while the latter made it affordable for the retail market.
The seismic nature of this shift cannot be undersold. Consider an investment advisor seeking to satisfy the individual needs of their clients across 10,000 individual investment portfolios. They’d need to manually ingest a mountain of client-level information, go about buying into hundreds of thousands of individual securities and monitor all accounts to identify portfolios that require rebalancing when they drift out of alignment. Prior to the advances described above, this would be cost- and time-prohibitive. Direct indexing offers this high degree of personalization in an automated fashion that is feasible for the investment manager, while better serving individual client needs.
When compared to the U.S., Canada has been slower to internalize the required pre-conditions to support direct indexing, but the outlook is increasingly positive. Leading direct indexing technology-solution providers in the U.S. are expressing interest in Canada as an expansion target. Additionally, Canadian broker-dealers are exploring ways to enable zero commission trading at scale. Fractional shares, at one time considered more of a marketing gimmick, is also slowly finding its footing as firms are tapping into lower account balance investors that are seeking alternatives to traditional funds.
Beyond these structural considerations, it’s worth examining whether demand among Canadian investors will be sufficient to justify bringing direct indexing to the Canadian market. For instance, the main driver for adoption of direct indexing in the U.S. is the opportunity to capture additional after-tax returns through direct indexing’s optimization capabilities. However, given tax code differences in Canada related to the treatment of capital gains, the benefit provided from tax optimization strategies deployed on Canadian portfolios will likely be less than those experienced by our counterparts south of the border. That said, believers in the concept remain steadfast that the increase in personalization for Canadian investors will be enough to drive demand for direct indexing.
Direct indexing likely still has a place in the Canadian investment landscape, despite the differences between Canada and the U.S.. The first ‘Canadianized’ direct indexing solution made available to the mass-market will have to navigate Canada’s structural nuances; if done successfully, investors aim to significantly benefit by accessing institutional investment capabilities at a cost likely competitive with most Canadian mutual funds.
Michael Thomson is director, and Jeffrey Joynt a consultant, with Alpha Financial Markets Consulting
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