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Raising the issue of asset owners as ETF sponsors

Mercer Investment Consulting’s Alex Bernhardt

The exchange-traded product landscape in the U.S. has a handful of examples of asset managers and institutional investors working together on specific offerings. Often developed through "reverse inquiry," these products have been built with a factor tilt, currency hedge or, more recently, an environmental, social, or governance bent.

But is the trend toward tactical or thematic ETPs actually too narrow? Do institutional investors and asset managers actually need to go wider?

Consider some of the initiatives undertaken by some of the largest pension funds in the United States: pushing for corporate board diversity, advancing climate change concerns, and taking a stand on issues such as gun control and opioids.

Outspoken pension systems and foundations, such as the California State Teachers' Retirement System and the New York City Employees' Retirement Systems, share their views in forums, news releases and investment policy statements. But their ability to influence corporate decisions — directly or by proxy — remains largely dependent upon other investors with larger individual and collective holdings, including index fund managers and active shareholders, who might choose to align with their views.

So, why not sponsor an ETF to extend their reach?

Alex Bernhardt, U.S. responsible investment leader for Mercer Investment Consulting in Seattle, said other U.S. and international products offer a road map.

"It's really a question of internal capacity — on administration, operations and liability," said Mr. Bernhardt. "The trend toward defined contribution in the United States also brings opportunity," Mr. Bernhardt said.

Examples include Mellon Capital Management's Carbon Efficiency Strategy, backed by The McKnight Foundation; a collaboration between Pitzer College and BlackRock (BLK) Inc. (BLK); and a green bond fund from Amundi and the International Finance Corp.

As publicly available investment products, ETFs could allow sponsoring institutions to wear their beliefs on their sleeves, while potentially lowering unit investment cost and extending their influence. For the asset managers, "reverse inquiry" ETFs such as the SPDR SSGA Gender Diversity Index ETF, launched with the California State Teachers' Retirement System, or BlackRock's iShares MSCI ACWI Low Carbon-Target ETF, launched with the United Nations Joint Staff Pension Fund, resulted in off-the-shelf vehicles with an asset base that could appeal to numerous other institutions and the investing public.

But the history of broad-based, ESG-specific ETFs is spotty and performance is mixed.

According to research firm XTF, a unit of the London Stock Exchange Group, 51 U.S.-listed ESG ETFs have only $6.1 billion in total assets, the largest of which is $1 billion iShares MCI KLD 400 Social ETF, launched in 2006.

Despite a recently lowered expense ratio of 0.25%, that ETF has marginally underperformed the S&P 500 on an annualized basis over a 10-year period, according to Morningstar Inc.

For the most part, these ETFs have held targeted, alternatively weighted U.S. or global equity exposures that appeal often only to the converted.

"Is ESG a risk factor?" asks Mamadou-Abou Sarr, director of product development and sustainable investing at Northern Trust Asset Management in Chicago.

"The uniqueness of the framework has brought about an interesting track record for new products and the ability to appeal to broader group," he said.

Now, in the U.S., could the current dialogue surrounding ethical investing — reignited by the Parkland, Fla., shooting — bring institutions and service providers closer to broader solutions?

The ETF community is always looking for strategies from which to create products. For example, Impact Shares, set up as a non-profit ETF platform with backing from The Rockefeller Foundation, is planning to launch index funds in partnership with the NAACP and the YWCA Metropolitan Chicago, separately, with an initial focus on social justice for minorities and women.

"In the U.S., this type of ETF product development is still evolving," said Ethan Powell, founder and president of Impact Shares in Dallas.

"How could active management be involved? What about governance policies and scalability?" he asked."

Keith Ambachtsheer, director emeritus of the International Center for Pension Management, sees both legal and incentive barriers to a pension fund, foundation or endowment fund investor extending its reach.

"Arguably, they have enough challenges facing them without getting into the retail market," said Mr. Ambachtsheer.