Firms see embrace of ESG as way to garner more fees

This earnings season, publicly traded asset managers assured shareholders they are positioned to reap the benefit of increased investor interest in ESG strategies.

But sources debate whether firms can count on fees from these strategies to deliver a more stable source of revenue compared to other active funds.

While there is a demand for environmental, social and governance products, it is still early to tell what impact it could have on manager earnings, said Matthew R. Crow, president of Mercer Capital Management Inc., a business valuation and financial advisory services firm in Memphis, Tenn.

"Ultimately, the new (assets) pouring into ESG products is not significant enough yet to affect anybody's earnings," said Mr. Crow, who leads the in- vestment management industry team at Mercer Capital.

And although firms' presence in the ESG marketplace has yet to materially impact their businesses, Mr. Crow says attention to ESG factors has already impacted money managers' ability to win new mandates.

"Both individual and institutional investors are (setting) mandates to put a percentage of their investments in ESG strategies. So, they are going to be looking for it in requests for proposals" for external managers, Mr. Crow said.

Gary Shedlin, chief financial officer of BlackRock Inc., New York, said in the company's fourth-quarter earnings call last month that its iShares ESG MSCI USA Leaders ETF raised more than $1 billion in 2019 alone after launching on May 9, representing the largest equity ETF launch in the industry in the past 15 years. The fund, which launched with more than $800 million from Ilmarinen, Finland's largest pension insurance company, had nearly $2 billion in assets as of Feb. 20. Ilmarinen managed €49.1 billion ($54.6 billion) as of Sept. 30.

During the Jan. 15 earnings call, Chairman and CEO Laurence D. Fink also noted that BlackRock intends to double its ESG ETF offerings to 150 over the next few years, to include "sustainable versions" of its flagship index funds.

Prior to its earnings call, BlackRock issued a letter to clients on Jan. 14 saying it was "making sustainability integral to the way BlackRock manages risk, constructs portfolios, designs products and engages with companies." That day the firm also issued a separate letter to CEOs pushing companies to confront climate change.

In response, Moody's Investors Service, New York, deemed the move a credit positive for the firm.

"BlackRock's scale and global reach (it reported $7.4 trillion in assets under management at year-end 2019) positions the firm to create products — and perhaps more importantly, the standards — that will establish it as a market leader in ESG investing," a Jan. 17 Moody's report said. "We expect the sustainable investing market to grow rapidly, and BlackRock's size and prominence, coupled with its recent commitments, will elevate its position in this market."

BlackRock's AUM was up 6.6% for the quarter ended Dec. 31 and up 24.3% for the year. The firm reported nearly $4 billion in revenues, up 7.7% over the prior quarter and up 15.8% year-over-year.

Among 25 money managers tracked by Pensions & Investments, all except two firms saw their AUM increase over the quarter, ranging from 0.8% at Franklin Resources Inc. to a 9.2% increase reported by Federated Hermes Inc. Twenty-two managers reported an increase in revenue as well in the fourth quarter.

Stephen Tu, a New York-based vice president, senior credit officer at Moody's, said in an interview that ESG products will "be a more stable and faster growing segment of the asset management marketplace."

ESG strategies, for instance, have inherent product characteristics that make them "less cyclical" and therefore "not as subject to macroeconomic factors, economic growth and market volatility," which can provide a more stable means of attracting fees for active managers, Mr. Tu said.

Still, excluding a few outliers, the percentage of total AUM that most money managers have in ESG strategies is, on average, "still relatively small, in the mid- to low single digits," he added.

In recent earnings calls for the quarter ended Dec. 31, other managers said they were poised to attract new assets into ESG, including Legg Mason Inc., Baltimore.

Joseph A. Sullivan, chairman and CEO of Legg Mason, said during the firm's Jan. 29 earnings call that the company had about $300 billion in ESG assets under management, which accounted for about 43% of the firm's long-term AUM.

"ESG factors and incorporating that in the investment process is really, I think, table stakes these days," Mr. Sullivan said on the earnings call.

San Mateo, Calif.-based Franklin Resources announced Feb. 18 it was acquiring Legg Mason to create a global investment manager with $1.5 trillion in combined AUM.

Mr. Crow at Mercer Capital said Legg Mason's ESG capabilities across its investment boutiques "was one of the things that attracted Franklin Resources to (the firm)."

J. Christopher Donahue, president and CEO of Federated Hermes, Pittsburgh, said during the firm's earnings call on Jan. 31 that the company was expanding its equity ownership services stewardship and engagement business in the U.S., and was hiring several new professionals to engage with companies.

The EOS business had $877 billion in assets under administration as of Dec. 31, up from $781 billion as of Sept. 30 and about $500 billion as of Dec. 31, 2018, Mr. Donahue said on the call. Hermes EOS provides stewardship services, including engagement on ESG issues, and proxy voting recommendations for institutional clients.

In July 2018, Federated completed its acquisition of a 60% interest in the London-based ESG manager Hermes Investment Management.

Federated Hermes reported AUM of $575.9 billion as of Dec. 31, up 9.2% from Sept. 30 and up 25.2% for the year. The firm reported revenues of $358 million in the fourth quarter, a 5.2% increase over the quarter and 16.5% increase over the fourth quarter of 2018.

Luba Nikulina, the London-based global head of research at Willis Towers Watson PLC, noted that flows into ESG strategies have increased significantly for managers over 2018 and 2019, and "in terms of the revenues, there is definitely a positive impact there" for firms.

Willis Towers Watson has also seen some firms "charge a premium for ESG funds," Ms. Nikulina said. "We do see it, but we challenge whether this is the right approach," she said of higher fees.

Ms. Nikulina said in the longer term ESG funds may provide a more stable means of active fees for managers since these strategies may inherently manage risk better. In the short term, however, investors may also have to contend with volatility concerns.

"You could create more volatility because you exclude certain stocks or even sectors if you invest in ESG-focused products, and the tracking error when you start measuring performance will be higher the more stocks that you exclude," she said.

And while some money managers have "raised their game significantly," as it pertains to investing through an ESG lens, many active managers still need to increase their resources for engagement with portfolio companies, Ms. Nikulina added.

"At the moment, the quality of engagement is not where it should be. There has been a change in the resources put into stewardship and engagement, but we need to see more," she said.

Lubasha Heredia, a New York-based partner and managing director at Boston Consulting Group and a core member of the asset management practice, said managers need to "articulate what their strategy is around ESG," then align their organization to that narrative and make sure they have right talent, data analytics and reporting capabilities to deliver ESG insights to clients.

Sam Iles, a New York-based senior manager and co-head of the distribution and data practice at Alpha Financial Markets Consulting, an asset and wealth management consulting firm, said it will eventually be the case that firms "can't be an active manager without being active on ESG and responsible investing" if they aim to generate long-term growth.