Active vs. passive ESG today

This video is part of our Earth Week special report

Ruth Saldanha: We believe that companies that seek to grow in a sustainable manner have better outcomes in the long run. As an investor though, it's hard to keep track of everything that's going on in the ESG space. And so, oftentimes we leave it to the professionals by investing in ESG funds. The question we are asking today is that should you go active or passive with your ESG investments? Mari Brossard, Director of Strategic Portfolio Management and Sustainable Investments at NBI is here today to share her point of view.

Marie, thank you so much for being here today.

Mari Brossard: Thanks for the invitation, Ruth. I appreciate the opportunity.

Saldanha: ESG is very subjective and it looks like ideas are still being formulated around what exactly ESG even is. In these circumstances should investors go active or passive with their ESG investments and why?

Brossard: This is a timely question because we just launched at National Bank Investments a suite of three sustainable ETFs and we had that same reflection not that long ago. And we tend to be evidence-based in our investment process, which means that we take decisions based on facts and research. And we came up with four arguments in favour of active over passive management, and I'll walk you through each of those arguments.

So, the first one is that we currently have less faith in ESG data. It's still a new field and there are various data providers out there. Each comes in with their own definition of ESG and their own methodology, which means that two providers can have a very different conclusion on the same stock. So, we tend to advocate that the human process is more reliable in those circumstances. It doesn't mean that we can't use ESG data, but it's an input in investment decisions. We are not making decisions only based on ESG data.

The second argument is that ESG indexes do not outperform their parent index over time. So, we studied the performance of various ESG index in the main asset classes and compared the return with their parent index or the non-ESG index of this asset class. And our conclusion was that you're definitely not leaving money on the table when you're using an ESG index, but there's also no significant clear alpha generation. And we all know that there's opportunity to create value for clients in the sustainable space.

The third argument where we came up with is that a quantitative process can lead to questionable names in the portfolio. So, if you're solely relying investment decision on certain metrics, such as woman representation on the board of directors, could lead to questionable names in your portfolio from a global ESG standpoint.

And the last argument that was that, our expertise in house at National Bank Investments is manager research and portfolio construction. It's not about building index. So, if you wanted to leverage the whole firepower of our team, well, we had to go active.

Saldanha: Well, two of the most important and popular styles in ESG, if one can call them so, is either to exclude certain sectors and companies altogether, or to engage with companies that already exist in what is often called problematic sectors. As a manager of managers with both kinds of arguments on your plate, which are the positives and negatives of both these styles?

Brossard: So, most of my responsible investment colleagues will prefer engagement over exclusion, because you have the ability to influence portfolio companies toward a better outcome. But I think that both could coexist. They come into play at different time, and they serve different purposes in an investment process. So, exclusions are often discussed before making an investment as opposed to engagement which is done during the investment process.

Saldanha: You mentioned quantitative processes and the issues that come with them. Now, one of the worries with passive products is that you have very little control. And sometimes mistakes can happen like last year, when an ESG ETF ended up holding gun manufacturers. Now, if you do like the passive route, then how should investors make sure that this does not happen?

Brossard: It all starts with a good understanding of the definition of either green, responsible or sustainability that's used in the investment process. You mentioned earlier that ESG is very subjective. So, the first step is making sure that everyone is on the same page. And then, there's communication between people product manufacturer, the investment advisors and potential clients. And the third pillar to mention is to avoid the situation that you mentioned earlier, so robust investment process and making sure to deliver what has been advertised to client. And for this, a good compliance or daily oversight that the investment product could really come into handy in order to avoid the situation that you just mentioned. And all this reiterates the value of active management over passive management. When you have a team of investment analysts and portfolio managers that are doing research, writing investment report and presenting them into investment committee, the level of responsibility and accountability is so different than when you're describing or creating index routes.

Saldanha: Thank you so much for being with us today, Mari.

Brossard: Thanks for your time, Ruth. We appreciate it

Saldanha: For Morningstar, I'm Ruth Saldanha.