Are European fund houses coming for US managers’ ESG lunch?

Big US fund managers have endured plenty criticism when its comes to their ESG integration, voting and stewardship activities.

From summonses to far-flung Texas courthouses to having their voting records pored over by academics, a number of highly vocal clients on both sides of the ESG divide have been increasingly putting pressure on asset managers.

As one example of the increasing polarisation, Rajith Sebastian, head of ESG and sustainable investing for the New York State Insurance Fund (NYSIF), told Responsible Investor’s US conference last week that when doing due diligence on a private equity fund, NYSIF had asked the manager to sign a side letter committing to giving them some climate disclosures.

The manager, he said, was happy to disclose directly to NYSIF, but noted that another state pension fund had asked for a side letter guaranteeing no climate disclosures to them.

Pension funds in Republican-leaning states have very publicly pulled money from asset managers, particularly BlackRock. And while the largest blue state funds have yet to take the final step, they have been increasingly vocal about their disappointment with managers pulling back from climate commitments.

The sums involved are relatively small for the largest asset managers. When the Texas Permanent School Fund pulled $8.5 billion from BlackRock in March, it represented less than 0.1 percent of the manager’s total AUM. BlackRock also raked in $200 billion of net inflows in the Americas in the nine months to end-September.

That said, European and UK managers with a strong ESG focus are sensing an opportunity to capitalise on disillusionment in the US, particularly for sustainability-focused allocations.

CalSTRS, for example, has handed two large mandates from its sustainable investment and stewardship strategies to Nordea and Ninety One, both based outside the US. The Nordea mandate, for $450 million, specifically mentioned the firm’s stewardship work, and its head of responsible investment said this was a trend in more progressive parts of the US.

Ninety One, which has been focused on building its Canadian business, is now “refocusing into a broader North American context”, according to Katherine Tweedie, Canada country head and, since October, co-head of the manager’s North American institutional client group.

As well as securing one of the CalSTRS mandates, Tweedie says Ninety One is in “pretty engaged” discussions with US public funds and family offices about its emerging market transition debt strategy, which has already secured commitments from UK and Canadian pension funds.

For large asset owners, she says, “the world is their oyster” and they will “go where they find the best options for both their investment criteria and the philosophy they want to back”.

Similarly, Sebastian noted that, when NYSIF began its sustainable investment journey a few years ago, “we leaned a lot on the European managers”.

Getting smarter

The increased scrutiny coincides with rising awareness and maturity of sustainability issues at some US funds. One client-facing figure at a London-based manager tells RI that asset owners in the US have become “increasingly sophisticated and educated over the past four to five years”.

“Five years ago, it used to be a lot of explaining why ESG was material, but now we have to explain what we are doing and how it fits into our research and engagement,” they add.

Similarly, Krissy Pelletier, partner and head of the endowment and foundation team at consultancy NEPC, says US asset owners are getting “more and more savvy and looking much further and much deeper”.

“Even investors who come to the table with strictly the investment-opportunity lens have gotten more savvy on digging deeper when there is a sustainability-minded fund, asking questions about the expertise of the team or additional resources that a firm is utilising,” she adds.

Sebastian agrees that NYSIF is digging deeper beyond the Powerpoint pitch level. “Put it in your pitch deck, and say, ‘We’re doing this, we’re super-responsible’, and I’m not going to believe that. We want to really rely on evidence”.

The London-based manager says European managers are at an advantage as they often have a wider range of sustainable products on offer.

However, the lack of any regulatory framework for sustainable strategies in the US beyond the SEC fund-naming rule means managers will have a more difficult time pitching these products than in Europe, where they can point to an Article 8 or 9 designation, they said.

Cost concerns

While fiduciaries may be looking to allocate more to dedicated sustainable products, or increase ESG integration in across their portfolio, performance and fees remain king for US asset owners.

Funding across public pension funds varies broadly and some are facing significantly lower funding ratios than their Canadian or European peers. So while there is more risk appetite, managers say performance is a sensitive issue.

According to Pelletier, there may have to be “hard choices” if underperformance of sustainable or ESG strategies impacts the spend rate of one of her clients or the work it is aiming to carry out.

However, she notes that many asset owners are being patient as some ESG strategies underperform and are willing to try and understand the underlying causes.

Other funds are less patient. This year, staff at the Los Angeles Fire and Police Fund recommended pulling a mandate from an ESG specialist over persistent underperformance.

While sustainability integration is also important for US asset owners, “you have to be in the top decile in terms of performance”, says Ninety One’s Tweedie.

There has been some underperformance in the Ninety One environment equity strategy, she acknowledges, as it does not hold Tesla or Nvidia. “But when you work with a long-term oriented investor like CalSTRS that has this commitment to the long-term thematic of decarbonisation, they’re invested with you for medium to longer-term returns.”

Also speaking at RI USA, Mercer’s global head of sustainable investment research, Sarika Goel, said the consultancy’s manager research team is finding that funds looking at “ideas within the sustainability and impact space” are broadly on par with “your core global equity investment strategy”, and remain cheaper than emerging markets funds.

She did note that environmentally themed strategies tend to be slightly more expensive and there are additional costs when managers were asked to implement exclusions lists specific to one asset owner client.

However, NYSIF’s Sebastian said he was seeing a “significant” fee discrepancy in some areas, noting that one green bond product charged 15 percent higher fees than a comparable investment-grade fixed income strategy.

Collaborative conundrum

While departures from Climate Action 100+ and other collaborative groups have mainly been driven by US managers, both Sebastian and Goel said they were not looking at membership of collective initiatives or networks in their assessments of managers.

NYSIF focuses on what actions asset managers are taking, Sebastian said, and that while membership of sustainability initiatives is a “good signal”, it can also discriminate against smaller managers or those with fewer resources.

Similarly, Goel said that given the “massive” number of initiatives that have sprung up over the past decade, “you can’t answer” which is the most important.

“It comes down to what is the manager’s commitment, their overall approach, their investment philosophy? That’s indicative then of their commitment and they can be quite focused in terms of what initiatives they are a part of.”

Similarly, a 2023 BlackRock survey of 200 institutional investors, around a fifth of which were in the US, found that just 6 percent of respondents ranked memberships as one of their top three considerations when selecting a manager for transition allocations.

Areas of most interest to investors were strength of research, access to deals, and then fund performance and managers’ approach to voting.

However, Matthew Illian, director of responsible investing for the United Church Funds, warned that systemic issues “need to be addressed systemically”.

“Yet a lot of the largest managers that we work with are pulling out of some of these networks,” he said. “They’re telling us that they’re still committed and on their own path. But I think asset owners will need to do some pushing in the years ahead to get collaborative network effects that we need in place.”