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Investors looking to put their money in sustainable areas are being forced to pay higher fees for active funds, due to a “concerning” absence of cheaper, passive vehicles, analysts say.
As part of the UK’s anti-greenwashing regime, new rules were introduced last month to apply some rigour to funds’ use of terms such as “sustainable” and “impact” in their names.
From April 5, any fund so named has had to adopt one of four labels developed by the Financial Conduct Authority, designed to guarantee that it really is investing in line with a “sustainability” agenda.
However, there is a near-total absence of index-tracking funds from the labels, due to the difficulty for broadly-diversified passive funds to meet the specific wording set out by the FCA’s Sustainability Disclosure Requirements.
“The absence of passive products is concerning, given their general prominence,” said Hortense Bioy, head of sustainable investing research at Morningstar Sustainalytics.
Bioy has identified 94 actively managed funds that have adopted one of the new sustainability labels so far, with combined assets of £35bn. Average fees for active equity funds are seven times those for passive ones, according to Morningstar data.
The only passive funds with a label are eight vehicles developed by Standard Life that can only be accessed via the investment solutions business of Phoenix Group, Standard Life’s parent company, and are not available for investment separately.
Morningstar said a further 325 active and passive funds, with assets of £280bn, make sustainability-based claims in their name but had not adopted any of the labels.
Exchange traded funds, which account for the bulk of the passive funds available to UK investors, are automatically frozen out from the SDR regime, as it only applies to UK-domiciled funds and all of the 1,850 ETFs listed on the London stock exchange are domiciled overseas, typically in Ireland or Luxembourg.
Many mutual funds aimed at UK investors are similarly out of scope. BlackRock’s passive mutual fund range, which dominates the sustainability landscape, is domiciled in Luxembourg.
More broadly, the hoops a fund needs to go through to earn one of the four labels — “Sustainability Focus, Improvers, Impact and Mixed Goals” — can be difficult for a passive fund to reach.
Under the Sustainability Improvers label, for instance, at least 70 per cent of a fund’s holdings need to be improving their sustainability, while the remainder must not be “in conflict” with this objective. This can be difficult to meet for index funds, which do not actively choose their holdings but include every stock or bond in an index.
In contrast, under the EU’s equivalent Sustainable Finance Disclosure Regulation, the rate of decarbonisation is measured at the portfolio level, rather than the stock level, so the presence of a handful of portfolio companies with rising carbon emissions would not necessarily be a barrier.
“[The FCA] have set the bar quite high. Existing [passive] offerings can’t make that threshold. Active funds have more flexibility to manage the funds the way they want,” said Bioy.
Shai Hill, chief executive of Integrum ESG, an environmental, social and governance data provider, said funds “have to demonstrate to the FCA how they are pursuing a sustainability objective. Instinctively it’s harder for a passive fund to say they are pursuing an objective when they are not actively managed”.
“I don’t think the FCA has achieved what it set out to do. They have created confusion,” he added.
The FCA declined to comment.
