The relentless innovation of the ETF industry and its ability to rapidly evolve could drive the move towards the development of further ESG solutions, not only responding to upcoming demands, but also creating them, says Fernando Aguado, CIO at the Spanish asset manager Fonditel.
Conversely, he believes the active investing industry will have to make greater efforts to prove its ability to generate alpha.
And to do so, it might need to offer tailored solutions capable to generate financial returns while creating a measurable positive social and environmental impact for investors. Aguado says: "However, since the challenge faced by active strategies to demonstrate their ability to generate alpha can be higher than that of proving their ESG value, the second may end benefited from the first."
When asked whether ETFs could face headwinds in future depending on regulatory developments, he states: "We believe this could be an upcoming scenario for ETFs in some niche markets on which the underlying asset's liquidity is lower.
"The great volume of some ETFs providing liquidity on a daily basis could give investors a false impression of liquidity and depth, which does not normally match the real features of the underlying asset.
"High yield, corporate, emerging market bonds, or volatility could be clear strategy examples of this scenario. And the January 2018's flash crash on short volatility strategies could also serve as a reminder.
"Some of these products could be systemic and we already know how regulators think - and behave - about systemic risks."
With regards to the impact that ESG may cause on the evolution of ETFs and index products as a whole, Aguado says that the focus on the adherence of ESG principles to investment portfolios is an ongoing trend in unstoppable growth. He says that although investor demand on ESG investing has been higher on the institutional side so far, it will also grow among the retail sector, which is likely to be reinforced by upcoming regulatory developments.
"All these factors will lead to the launch and development of a new era of ETF and index products, able to keep existing investors while attracting new ones, as long as they meet their ESG demands."
Aguado foresees that the ETF & index product industry will continue growing as a whole.
When asked how ESG integration in fixed income processes compare with those on equities, Aguado sees the ESG bond market at an earlier stage of development. According to Fonditel´s chief of investments, the ESG bond market is still on a development phase, whose greatest achievements could be considered the issuance of social and green bonds which, "can be comparable to the ´best in class´ solutions."
He continues: "The integration of financial and non-financial risks in the fixed income space is still under construction. This is the reason why shared standards are not yet in place and why there is a lack of clarity and consensus on the different criteria, such as on the country exclusion, the potential weight on the implementation…"
"ESG rating agencies have not managed to reach yet a consensus on both the ratings and methodologies. There is also confusion around the taxonomy and definition of the different styles and products, as well as a complex coexistence between those using ESG as a marketing tool and those truly committed to it.
"Regulators will be playing a key role in accelerating the ESG implementation by promoting a standardisation of its definitions and taxonomies while helping investors to distinguish between products and remove the potential of greenwashing."