Macquarie: mitigating ESG execution risks

Macquarie: mitigating ESG execution risks

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Macquarie Paul McGee Thoughtleadership Transition Management Guide 2023

Avoiding ESG execution risk: how to switch mandates and launch funds

Paul McGee, head of portfolio solutions EMEA, Macquarie Capital

This article is part of the 2023 Transition Management Guide, which can be accessed here.

Beneficiaries and investors are increasingly demanding exposure to ESG strategies across their public equities portfolios. Switching mandates or launching funds into a crowded market is fraught with risk and should be carefully managed. 

A large-scale transition is underway in investment management

Driven by a combination of client demand and regulatory impetus, fund managers are increasingly adopting investment strategies that incorporate environmental, social and governance (ESG) factors. Bloomberg estimates that by 2025, ESG assets are likely to exceed $53 trillion, accounting for more than a third of global assets under management.

As a result of this multifaceted demand, the transition management landscape is increasingly complex with heightened activity across both retail and institutional markets. Many investors - including corporate and government pension funds, sovereign wealth funds and high net worth individuals - are channeling more of their portfolios into mandates pursuing ESG strategies while at the same time, investment management firms are developing new ESG funds to meet additional demand.

However, switching mandates or launching funds in such a crowded market is complex and risky: managed badly, either process can result in unnecessarily high costs, hitting initial performance and inflicting reputational damage.

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 such as 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 approximately 11% 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 initial performance.

Keeping costs down and performance up

It is for these reasons that we are seeing a growing number of managers using our transition management service, supported by Macquarie’s multi-asset trading desks. Our service aims to minimise costs and maximise fund performance, with centralised management of all stakeholders in a transition, detailed trade analysis and full project management.

By enabling a holistic view of a fund’s transition, clients using the service can understand which assets can be retained from the previous portfolio to the new one, helping to reduce trading and minimise cost.

They can maintain market exposures and minimise performance holidays and, by accessing our risk management capability, manage the volatility and market impact that can be associated with specific ESG names.

Feedback from our clients is testament to our capabilities:

“We are very happy with our decision to use Macquarie’s transition management team to launch new mandates for our sustainable equities portfolio,” says David Cox, deputy chief investment officer at Brunel Pension Partnership.

“They made the process as smooth as possible, coordinating the multiple stakeholders involved and designing sophisticated trading strategies to minimise costs and risks. Our clients were very happy it would support the portfolio as it invests in companies that provide a tangible benefit to society.”

 The adoption by the investment market of ESG orientated strategies is not without its controversies and differences of opinion, with live debates underway as to how ESG investing should be defined and how best to address greenwashing.

Nonetheless, a process is firmly in train by which ESG factors are increasingly becoming integrated into investment management, and asset owners and managers are responding. As they do so, they need to approach fund transition and new launches with focus, discipline, and careful coordination.

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