Movers and SHAKERS
SEC Prioritizing ESG Investment Products May Uncover a Supply Problem
Earlier this year, the Securities and Exchange Commission (SEC) announced its exam priorities for 2021. The first priority mentioned in a press release was ESG related. Specifically, it stated, “This year, the Division is enhancing its focus on climate and ESG-related risks by examining proxy voting policies and practices to insure voting aligns with investors’ best interests and expectations, as well as firms’ business continuity plans in light of intensifying physical risks associated with climate change,” The acting SEC Chair said, “Through these and other efforts, we are integrating climate and ESG considerations into the agency’s broader regulatory framework.
The Division of Examinations at the SEC is responsible for initiating the reviews of products purported to follow the ESG guidelines outlined in offering documents of mutual funds, ETFs, and securities, (both public and private). The intention is to make sure investors have a clear idea of what they’re buying, also the nature of the instrument should not change without proper notification. In the case of actively managed funds, the underlying holdings must match investor expectations.
In practice, this is necessary for those that are either self-directed investors or manage money for others. If an investor believes that ESG investments are growing in demand and thus decides to allocate 20% to an ESG fund, meanwhile that fund is only 40% allocated to ESG investments, the investor is not allocated based on their portfolio design. Especially if the investor expects the investment vehicle to be 95% or more exposed to the category. In this case, the investor surely is not getting the product they bought nor are they achieving the allocation they deemed prudent.
The SEC in Action
In an August 1st article by The Wall Street Journal titled: “Fired Executive Says Deutsche Bank’s DWS Overstated Sustainable-Investing Efforts” the WSJ reported the Sustainability Chief of the DWS Group told investors that environmental, social and governance concerns are at the heart of everything it does and that their ESG standards are above the industry average. The now-former Sustainability Chief at DWS has recently said that, behind closed doors, it has struggled to define and implement an ESG strategy and that at times they presented a more positive front than reality.
Yesterday (August 25), the Journal wrote a follow-up story that the SEC and federal prosecutors are investigating whether DWS overstated its sustainable investing efforts. DWS is not a small player in the asset management arena with $1 trillion under management. Certainly, the impact of this investigation, still in the early stages, will have ramifications on the sector. How the sector behaves, remains to be seen. But the impact could be in the form of added upward price pressure on stocks that most solidly fit within widely accepted definitions of sustainability or ESG. It may even cause stocks and other securities that are borderline to be sold out of funds for fear of failing a regulator's examination.
The Growing Sustainability Sector
At the end of 2020, CNBC reported that sustainable investing is surging and accounted for 33% of assets under management, driven mainly by institutional buyers. In July, Morningstar reported that global sustainable fund assets hit a record $2.3 trillion during Q2 2021. While many companies are “greening” their operations and making policy changes in their Human Capital divisions, the demand for securities within managed funds may be outpacing what is available in “size.”
For investors that don’t trade in large lot sizes, this may present an opportunity to benefit from the difficulties large funds may be having fulfilling the requirements of their prospectuses. If this is true, small accounts buying individual stocks may have an advantage over funds.
The growth of investing in sustainability or ESG companies has led to a huge shift in portfolio allocations. From the point of view of an investment advisor or individual, an allocation change often is as easy as selling out of one fund and buying into another -- one that sincerely works to invest in companies that meet this category and simultaneously target value, growth, or income. With the large trades some funds must make to stay invested, even the best-intentioned fund manager may run out of good opportunities within the category. This is not necessarily the case for the individual self-directed investor or advisor that is adept at analyzing and reading the research on individual companies. For the average individual, there are more opportunities to fulfill their smaller size requirements than there are for the $2.3 trillion in managed by funds.
Channelchek provides information for investors to explore small and microcap stocks in many categories; within the Company Data section, investors can review stocks to decide what meets requirements important to their allocation decisions.
Managing Editor, Channelchek
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