Timing is everything
For asset owners, any switch of mandate is logistically difficult. Careful coordination is needed to maintain exposure to the markets in which it is invested, and to avoid excessive costs. Managers who lose mandates might not prioritise trading out of positions carefully to ensure the best outcomes for their outgoing clients and this can result in them exiting large positions too quickly – signalling their intention to other market participants, causing prices to move against them and thus increasing costs.
Similarly, investment managers launching new funds can face timing issues, with the need to invest client seed money in a tight timeframe. The investment manager needs to be able to deploy capital quickly to establish market exposure almost immediately; failure to do so can create a drag on performance against the benchmark that can be difficult to overcome.
Concentrated and volatile
These challenges can be exacerbated by the nature of some ESG strategies. They often identify a subset of issuers which score highly on various ESG characteristics, whether climate risk management, employee relations, or the diversity of their boards or workforce. Consequently, such strategies tend to be more concentrated than strategies that invest across entire benchmark indexes.
This concentration risk can have major ramifications. Electric vehicle manufacturer Tesla, for example, has grown so rapidly that it accounts for 11 per cent of FTSE Russell’s ET50 index, of the 50 leading global environmental technology companies, and has become the fourth largest weighted company in the S&P 500 Index. For many ESG strategies, Tesla is a significant holding, meaning that moves in its share price can have a major impact on strategies’ performance.
Furthermore, trading into these volatile ESG-related stocks in the first instance leaves fund managers susceptible to market moves on the way in. This leads to many funds overpaying for exposure to the market, dampening…
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