ESG and passive investing – not mutually exclusive

Two of the major trends in the asset management industry over the last decade have been the shift from active to passive investing and the increased focus on integrating environmental, social and governance (ESG) factors into the investment process. While there would seem to be no correlation between the shift to passive investing and the rise of ESG as a key topic for investors, these two trends are not necessarily mutually exclusive.

At first glance ESG and passive investing seem to be fundamentally at odds with each other: how can you integrate ESG into the investment process when passive investing does not entail any active decision making. Indeed, that would generally be the argument from advocates of active managers. However, this view may be too simplistic.

According to analysis by the Wall Street Journal almost all S&P 500 companies can count either BlackRock, Vanguard or State Street as an at-least 5% shareholder. As major shareholders in these companies, asset managers carry significant weight and voting rights. Increased public pressure alongside this weight gives passive investors access to, and real influence over, company boards allowing investors to engage with these companies and promote long-term shareholder interests.

This has already been demonstrated by Legal & General Investment Management who have used this power to vote against the election of more than 3,000 directors globally in 2018; voted against more than 100 UK chairs on gender diversity grounds and supported several key resolutions relating to climate change.

Therefore, while passive and ESG may not go directly hand-in-hand, through active stewardship passive investors are still able to make a significant contribution to the increased adoption of positive ESG practices. This is of particular relevance due to new DWP regulations that will shortly come into effect for large UK pension schemes, which will almost certainly lead to managers of active and passive strategies being asked to demonstrate how ESG factors are incorporated into the investment process.