Head of ETFs
Late last year, Nuveen Investments, a subsidiary of TIAA-CREF, launched five core asset-class ETFs based on a methodology driven by environmental, social and governance selection and weighting criteria. ESG investing has been a rising trend in the ETF space, with several such funds launched in 2016 and just as many filings made. Here, Martin Kremenstein, Nuveen’s head of ETFs, discusses the firm’s product lineup and why its strategies make sense for investors.
Would you talk about the key features of Nuveen’s approach to ESG investing?
The way we have come at this is to say that if a client really wants an advisor to incorporate ESG in the asset allocation, in the portfolio management, it’s all about trying to include it across the book.
It’s not about saying, “All right, I have a 10% allocation to ESG.” It’s about saying, “I take on board your values and your desires, so I will build a portfolio with an ESG overlay to it.” It’s about really making ESG filtering and ESG ranking part of the actual portfolio, right in the core of it.
So, the approach rejects looking at ESG investing as a tacked-on strategy, and moves it to the core of the portfolio.
That’s right. That’s why we started with the five very standard domestic asset classes covering size and style—large growth, large value, mid-growth, mid-value and small-cap. We worked with MSCI to build custom indices that would incorporate ESG ranking and selection, but also be within fairly tight risk tolerances of their non-ESG parent indices.
TIAA, Nuveen’s parent company, has a long history with ESG-type investing, but ESG has been a bit out of the mainstream. Why has it taken so long for it to be accepted in the mainstream?
You’re right. TIAA has been running ESG and responsible investing accounts since 1990, and responsible investing mutual funds since 1999. So we’ve been doing this for a long time. It’s really something that is core to the DNA of TIAA, which, when you think about our historical customer base—which is teachers and nonprofit workers—that’s not particularly surprising.
When you think about the broader pickup, there’ve been a lot of products that’ve come to market, and we have an edge in the fact that we’ve been doing this for a long time. We spent a long time with MSCI building these custom indices so that they reflected what our ESG research team believes is important. And again, because we’ve been running client money in this space so long, we also had the expertise to make sure these indices weren’t going to be so far away from their parent non-ESG indices that the return streams would be that unpredictable.
When you think about the broader pickup in assets, you definitely see it coming from the institution level. We’ve seen a lot more endowments, foundations and pensions seeking to reflect their core values in their asset allocation, in their investment mix. I think that filters down to the retail level.
When you look at the current growth, you see two things. One is millennials—they don’t have a ton of money to invest individually, but they’re a big group, and are much more keen on values-based investing than prior generations. And then there’s the gender mix. Women tend to be, I think, more focused on values-based based investing, or at least take it more seriously. And they’re starting to control more money now. Those two things have set up the retail market to be a more interesting space.
And finally, part of what generates demand is opportunity: Now there’s more opportunity for investors to incorporate their value systems into their investments.
There’s always been this perception that, to do value investing, you have to sacrifice returns. How does the methodology balance the need for solid returns with the investor’s desire to invest according to their beliefs?
It’s actually not about divestment. We’re not just saying, “We don’t do anything in this sector or that sector.” By choosing the best-in-class ESG leaders in each sector, you’re ending up with something very similar to the broad market, but you’ve then made a values choice in how you construct it.
Historically, the backtests for the indices have performed very much in line with their parent indices. Midcaps have shown outperformance, as have small-caps. I think the only one that showed any real lower returns was large-cap growth, and that seems to be the result of how certain technology companies are handled. Some tech companies have interesting governance setups, so that can skew things a little.
And 80% of returns come from asset allocation. As long as these indices and funds are set up to track the broader market closely, there should be very little to no cost from it. And then you also stand a chance of actually getting some outperformance because they are more efficient companies. The ones that are more environmentally efficient are also wasting less. Companies with good governance tend to be better run. Companies that don’t have controversial businesses lines tend to not get hit with so many class-action suits.
I think screening for ESG can actually improve returns. What we’re doing is really trying to match the broad market while improving on values-based investing.
ESG seems almost like a forward-looking factor in how it expects to reap the benefits of more environmentally and socially conscious practices and better governance practices. Is that a proper way to characterize it?
The idea that long-term performance can benefit from a screen for ESG factors I think is fairly well researched and stated. I wouldn’t argue with that. In terms of long-term performance, I think asking for companies that are basically more efficiently run and have good governance sounds like a fairly sensible screen.
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