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How Passive and Sustainable Investing Can Intersect

Jon Hale, Ph.D., CFA

Jeremy Glaser: For Morningstar, I'm Jeremy Glaser. We recently published a survey of the passive sustainable investing landscape. I'm here today with Jon Hale, he is our director of sustainable investing research, to look at what's happening in that space.

Jon, thanks for joining me.

Jon Hale: My pleasure.

Glaser: Let's talk a little bit about that intersection of passive and ESG. I know we've talked before about how sustainable investing is not about creating these rigid screens. But how does that translate into a passive rules-based strategy then?

Hale: Jeremy, the development and increasing sophistication of ESG company-level research over the last decade or so has made it really possible to do passive ESG indexing in a way that in years past it was primarily oriented toward maybe a few exclusions and then that was pretty much it. But now, what you can do is structure a portfolio around companies that, based on ESG research, are those that do a better job addressing pertinent environmental issues, social issues, that engage in best practices in corporate governance. These are companies that over the long term are fairly likely to have good risk-adjusted returns and are high-quality companies. It's more possible today to create an index based on ESG factors than ever before.

Glaser: Let's talk about how some different index providers are actually creating these indexes then. Are they all looking at company-level research? Are there other factors at play?

Hale: I would say, pretty much everyone is looking at company-level research. But you could think of--especially, the broad-based ESG indexes. But you can sort of think of these in three types of categories. There is the broad-based index that could substitute for a market-cap-weighted conventional index. You've got that. You've got over on the other side some very thematic-oriented indexes around things like renewable energy or green bonds. And then kind of in the middle you have, what I would call broad thematic approaches that are diversified portfolios, but they focus more intently on issues like low carbon, fossil fuel-free, for instance, or gender diversity.

Glaser: Have these funds started to take off? Has there been a lot of investor interest in them?

Hale: There's a lot of investor interest, on the one hand, in ESG-oriented investing, and on the other hand, in passive investing. The number of these funds has taken off. We have not seen an avalanche of assets go into them yet, but I think what we are seeing is, asset managers and index providers developing the products that will be able to meet the demand going forward.

Glaser: For an investor who cares about sustainability, is the decision between going active and passive the same decision that they'd be making if they were looking at conventional funds or are there any other special considerations?

Hale: It is generally the same kind of decision. If you are interested in both sustainable investing and passive investing, there is no reason why you shouldn't go the passive route. I think the one area that they ought to be thinking about if you want to go passive and sustainable is, is the asset manager engaging with companies as a shareholder. In some cases, with index providers, the answer is, no; in other cases, it's yes. For instance, iShares, owned by BlackRock, we know BlackRock has been quite active in shareholder engagement and I think that's something that's important for sustainable investing in general. I think the sustainable investors themselves feel like they have a greater impact with their money by investing in those kinds of portfolios.

Glaser: Jon, thank you.

Hale: My pleasure.

Glaser: For Morningstar, I'm Jeremy Glaser. Thanks for watching.