Over the last few years the appetite for 'greener' products has become a global trend while the financial sector has reacted and is participating more actively in providing investment solutions with a 'feel-good' factor that are also being used to fund social initiatives such as eradicating extreme poverty, boosting shared prosperity and address income inequality, according to panellists debating thematic, quantitative, and environmental, social and governance (ESG) trends in the structured products market at SRP's 14th Annual European Structured Products & Derivatives Conference, on February 1, in London.
"At Natixis, the environmental and financial impact of investing is core to our clients, and we look at building our offering in a holistic way," said Asra Abdulaziz, head of sales, equity derivatives, Emea, at Natixis.
ESG investing started with the turn of the Millennium when FTSE developed the FTSE 4 Good index, an index aimed at introducing filters and excluding stocks based on ESG criteria which made it a suitable tool to be used by a wide variety of market participants when creating or assessing sustainable investment products, according to Dan Carson (pictured), senior investment analyst, sustainable investment at FTSE Russell.
"However, this segment has evolved since then and become more sophisticated, more data driven and more mainstream," said Carson. "ESG is now seen from a value driven economic standpoint as much as an ethical consideration as investors increase their awareness around climate change and governments take action to address the problem by shifting towards a low carbon or green economy as we saw recently with the 2015 Paris Climate Conference (COP 21)."
This change in mentality has resulted on a number of low carbon strategies being made available to institutional and retail investors. Wells Fargo has been working on this kind of investment since 1998 when it began to look into building strategies that would address the growth of the global population and the increase in the use of the raw materials, according to Dan Raab, head of commodity index products marketing at Wells Fargo.
"This is now a growing trend especially around the use of electric vehicles which are 3.5 times more efficient that fossil fuel cars, while the price of batteries has also fallen significantly," said Raab. "Currently there are 1.5 million electric cars globally but the projection is that there will be 100 million electric cars by 2035 which gives an idea of the changes in the demand for fossil fuels and renewables. Oil demand is also expected to decrease."
As new strategies reach the market place investors' demand is also shifting and the number of structured products linked to ESG and sustainable indexes launched over the last few years is testimony of the increased demand despite claims that ESG is not compatible with performance.
"There is a trade-off with everything we do," said Walter Cegarra, managing director, equity derivatives & fund linked products at Credit Suisse. "Because of the exclusive focus on low carbon, we have missed some opportunities around fossil fuels. Coal had a good year in 2016 and some mining companies performed very well and were very profitable. I understand this might not be fashionable but there are areas within the fossil economy where there is money to be made."
HSBC recently moved its entire DC UK pension fund worth £2bn to a climate risk aware fund that combines climate factors with smart beta, and the performance of that fund has been more than acceptable, according to Carson.
"We have diversified fossil free fund at FTSE Russell which shows outperformance versus the benchmark of about 15% over the last five years so there's definitely scope for outperformance with ESG investments," said Carson.
Panellist also discussed how climate change has become a new kind of risk premia, and product providers are developing new systematic and actively managed strategies around these themes.
"We are asking ourselves if ESG is the new Beta, and developing long term strategies because there is no question we are moving towards a new type of economy," said Lorraine Zafrani, global head of structured asset management at AXA Investment Managers. "It is no longer a question of 'if' this strategies will be included in investors' portfolios but about 'which' and 'how' to include them. We are seeing an increase of these strategies and the products available also provide exposure to different ESG factors, and this is where we see scope for new underlying strategies whether they are systematic or actively managed around asset classes and cycles."
According to Zafrani, it is the responsibility of product providers to offer products that perform and provide good outcomes to investors. "As it was mentioned in another panel discussion, innovation is no longer around the payoff of structured products but about providing added value through the underlying strategy or index.
This approach is also in line in changes in the way investors are looking at their investment portfolios and the kind of products they want to deploy, according to Cegarra.
"Over the last three years were have seen a shift towards simpler structures and straight forward and transparent underlyings," he said. "The reason for that is that they can identify easily the premia. By using simple strategies around equities we can provide yield enhancement products as well as risk control compared to other asset classes, and add diversification to portfolios."
The panel concluded that ESG is now part of most banks' strategies and that the level of engagement with this segment will continue to increase as climate change forces us to look for alternatives to the ways we consume and invest.
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