In the face of growing interest in passive investments, we remain confident of the benefits that actively managed investment solutions offer investors. With environmental, social and governance (ESG) factors gaining more prominence in the investment world, active managers are increasingly integrating these factors in their investment process. We believe that active management offers engaged stewardship and responsibility in an ethically conscious world. This contrasts sharply with passive management, which has no choice but to hold a company share that is part of its target index, whether or not it meets ethical standards or guidelines.
Pick up any publication related to the asset management industry, and you will likely see a prediction or a call for the death of active investing. Over the past decade, the growth of assets into passive vehicles has turned exponential. This trend began with the 2008 global financial crisis, from which point there has been a change in fortunes even for the fully-flexible, premium end of the industry (Figure 1).
Figure 1. The rise of passive investing
Hedgefund performance relative to S&P 500 & ETF AUM growth.
Source: Bloomberg, Investec Asset Management HARP 30 September 2017
We believe that some investors may be overlooking the key stewardship role that only active managers can effectively play. If active management is indeed declared dead, there will be long-term negative impacts on the broader economy. It may reach a tipping point that exacerbates many of the worst attributes of financial markets. Some of the potential side effects include:
Poorer allocation of capital
In order for capital markets to function optimally, it is crucial that they are liquid, transparent and act as a mechanism for efficient capital allocation. At a company level, active managers play an important role in ensuring that markets have these characteristics. Only through a fundamental understanding of company strategy can investors facilitate efficient capital allocation which, in turn, is an important driver of economic growth.
Decreased support for new companies
Passive funds will not take a strategic decision to support a new company with an anchor shareholding in an initial public offering. If companies cannot raise funding in the equity market, they will have to raise debt funding and possibly become over-indebted and vulnerable to the interest rate cycle. There is a real danger that they won’t raise any funding at all – entrepreneurship will be stunted, innovation will slow and economic growth will suffer.
Decline in shareholder oversight of company management
Passive managers take no view on the quality of a company’s management or long-term strategy. Thus, they have little opportunity to provide shareholder oversight of company management, their environmental practices or their labour policies. Since the financial crisis, there has also been a greater focus on assessing companies against ESG criteria. These cover a wide range of complex issues that are becoming increasingly important to investors. Examples include: climate change impact and opportunities, carbon emissions, supply-chain oversight, and labour relations and remuneration.
As a responsible active manager, we play a meaningful role in promoting appropriate systems of governance, and the sustainable management of environmental and social factors for the companies in which we invest. We monitor, evaluate, and if necessary, actively engage or withdraw investments, with the aim of preserving or adding value to our clients’ portfolios. Of course, we consider these issues in the context of company valuations and the overall portfolio.
As an industry, this approach to active management may have material positive implications for the market and, in the longer term, for society. In a world where investors are increasingly becoming more socially responsible and understand the need to create an environmentally sustainable future, passive investing may not address their needs. Individual client requirements are also playing a greater role with exclusion-based mandates no longer sufficient to link ESG to client preferences. It is clear to us that ESG integration across our investment strategies is in the long-term interests of our clients and the wider society.
We believe this will be one of the most important topics in markets in the coming years and underpins why we have focused on ESG integration over the last few years. Active managers have real power to influence companies in the interests of investors and wider society.
We aim to preserve and grow the real purchasing power of the assets entrusted to us by our clients over the long term. In fulfilling this purpose, we assume a stewardship role, including the effective exercising of our clients’ ownership rights. We monitor, evaluate, and if necessary, actively engage or withdraw investments with the aim of preserving or adding value to our clients’ investment portfolios.
Our commitment and approach to stewardship is underpinned by a robust Stewardship Policy1 which outlines our key priorities and principles, and is available on our website. All our ESG-related policies and activities are overseen by an internal Investment Governance Committee (IGC). We have been building a global ESG capability since 2011 to manage and execute the stewardship mandates throughout the business. For more information about our Stewardship activities in the financial year 2016-17 please read our Annual Stewardship Report.
1 Investec Asset Management’s stewardship statement can be found at www.investecassetmanagement.com/expertise/stewardship/reports-library/. Our recently launched sustainability initiative highlights how we will act as a firm.
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