The unique properties of thematic investments, targeting the UN’s sustainable development goals (SDG) and methods for engagement were among the topics discussed in ETF Stream’s webinar on combining ESG with thematic ETFs in partnership with BNP Paribas Asset Management.

The webinar, titled Combining ESG thematic and indexing investments, started by positioning thematic strategies within the universe of environmental, social and governance (ESG) products.

Lorraine Sereyjol-Garros, global head of ETF and index sales team at BNP Paribas Asset Management, stressed: “Sustainable thematic investing brings a new dimension to the usual asset classes, allowing investors to diversify their portfolio.”

Rather than taking a broad-brush stroke view or tilting towards companies with comparably favourable performance on ESG metrics, thematic ETFs offer a precise way of buying into specific industries driving structural change, with the aim of outperforming in the medium-to-long term.

Edmund Shing, global CIO at BNP Paribas Wealth Management, noted: “By having such a wide choice, investors can choose a broad, general, sustainable ETF or they can be more selective and thematic in terms of one subtheme, relating to governance, social elements, or something more environmental.”

Thematic investments also differ in two ways, Shing said. First, they are great for storytelling as investors can align their moral views with their investment decisions. Second, they offer unique risk-reward profiles.

“Typically, a thematic approach might expose you to more risk but also the potential for more upside, so you are taking a higher risk-return approach as opposed to a more generalised approach,” Shing added.

“However this is not always true, for instance funds with a greater focus on corporate governance, they can act to reduce risks on a stock-specific basis, because you are using a methodology that will allow you to avoid companies that may be exposed to reputational risk, stranded assets and even corporate fraud.”

Overall, this ability to differentiate from core holdings and appeal to investors’ emotions have been key drivers of thematic uptake.

Evidencing this, Sereyjol-Garros said: “Institutions applying ESG in their portfolios through thematic investing moved from 3% in 2019 to 28% in 2021, according to research from Natixis Investment Management. The number of fund selectors employing ESG thematic investment has risen from 6% to 43% during the same period.”

Precise plays for the climate-conscious investor

Undoubtedly, the bulk of flows in ESG thematics have gone to ETFs addressing climate goals through carbon reduction and industries central to the energy transition.

For context on this theme’s prevalence, Sereyjol-Garros noted there are around 250 ETFs addressing climate goals compared to one or none for other areas of importance for sustainable development.

Shing suggested a reason for this is the simplicity of environmental issues, their prevalence in public discourse and the ease and range of related exposures that can be captured within an ETF.

He added: “It is something we do discuss a lot with clients but it is also something they want. It is something they have heard about a lot; they are most convinced about this aspect.

“We have to do more work to convince them on the ‘S’ and the ‘G’ benefits but when it comes to the environmental benefits of climate investing, we are pushing at an open door. We need to give clients what they want and this is one of the key themes they are looking to integrate into their portfolios.”

Environmental themes are also numerate and easy to be approached from a number of angles, including carbon credits, company exclusions from indices based on carbon intensity, carbon ‘journeys’ or targeting the ones making the biggest improvements on their pollutions and of course, specific, burgeoning industries like clean energy and battery technology.

UN SDGs as the thematic ESG hymn sheet

Aside from climate goals, the UN’s SDGs are increasingly being used as a framework by wealth managers to identify sustainable investment themes.

“SDGs are a great way of seeing whether a particular thematic investment can be linked to a particular sustainable outcome,” Sereyjol-Garros argued. “They are impact indicators and can help you find an ETF that matches your priorities.”

Aside from clean energy, she pointed to SDG goal 14 – life below water – which is only addressed by the BNP Paribas Easy ECPI Global ESG Blue Economy UCITS ETF (BLUE).

This involves sustainable use and management of marine resources and ecosystems which BLUE targets by capturing companies involved in coastal livelihood (such as ecotourism), energy and resources (including offshore wind and tidal power, sustainable fisheries, pollution reduction and maritime transport.

Shing also pointed to SDGs one and two – no poverty and zero hunger – and highlighted the importance of investment in agriculture to facilitate better crop irrigation and provision of low-cost fertiliser. This, he said, would have a pronounced and positive impact in limiting malnutrition and the cost of food in developing countries.

However, Shing revealed his top pick is the circular economy, given it addresses SDGs associated with poverty, sustainable communities, responsible consumption and production. He added the theme is easy to understand, gaining popularity but has a lot of potential to mature further.

On the use of SDGs, he concluded: “They are quite vague; they are more of a marketing tool than anything else. They do get the seal of approval, like the EU taxonomy, which gives investors reassurance that it is something that has been thoroughly researched and is politically-backed.”

Possibilities for engagement

Despite thematic ESG ETFs trying to focus on more virtuous actors, a key component of strong ESG performance is ensuring companies maintain their standards over time.

On this, Sereyjol-Garros said: “For companies whose actions are inadequate, we increase our dialogue with them and make our views known through voting and tabling motions.”

Offering a practical example, she added BLUE invests in seafood sourcing companies from Japan. Given Japan is in the “relatively early” stages of fisheries with sustainability, she stressed the importance of their engagement activities last year, with this engagement set to continue in 2022.

Shing continued, stating his team implement a clover rating across all their products.

“Within this for funds and ETFs, for each fund manager and issuer, what is their engagement policy? Is it robust enough? Does it meet our criteria? This is reflected in the clover rating.

“Those that better register their engagement policy, they have a higher clover rating, they are viewed as more sustainable funds and then we are more readily able to recommend them to our clients,” he concluded.

To watch the full webinar, click here.

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