AP1 has seeded a new ESG equities fund, as it seeks to “replace all passive mandates” in emerging markets to make them more sustainable.
The SEK333bn Swedish pension fund, which runs $4bn in emerging markets – all via external managers – has invested $100m in the new pooled vehicle from BlackRock, which takes a “systematic” approach to emerging market equities, with an emphasis on material ESG elements.
“At the moment, we are evenly split between passive and active in our emerging markets portfolios,” explained Tina Rönnholm, a portfolio manager at AP1 specialised in ESG and external management. “But we want to increase our sustainability in the space and we think that’s best achieved through a more active style of management.”
Two years ago, AP1 put out a call to the market to help it shift to a ‘less passive’ approach in emerging market equities.
“We wanted to preserve the characteristics we like from passive – liquidity, market exposure and low fees – but become more active to enable better sustainability performance. So we issued that challenge to almost every big passive and quant house we knew of, to see what they would come up with.”
Rönnholm said cost was an issue for some of the asset managers, who saw the solution as an active one, and expected the fees to reflect that. Breadth was also a challenge when it came to ESG, she said. “Many came up with low-carbon solutions. Those products are many-fold, but ESG is much more than carbon.”
But data was the main stumbling block, with many citing the limitations of company disclosure on ESG issues – especially in emerging markets.
“It’s true, but at the same time, this is 2018 and there is an abundance of information out there. It doesn’t need to be based solely on company disclosure, because that’s generally out of date anyway, and you can’t expect to make money out of old data.”
The fund AP1 has selected uses BlackRock’s Systematic Active Equity Team, which looks at company disclosure and fundamental data, but also assesses “more unstructured” information from sources such as news outlets and social media. The more real-time data will enable AP1 to find opportunities that have not yet been priced in, Rönnholm claimed. “And it stops us as investors being reliant solely on companies for disclosure.”
BlackRock’s strategy has been used in developed markets, but until now not in emerging markets. The new fund is currently licensed in the Nordics and Netherlands, with further jurisdictions expected to be included in future.AP1 agreed a tracking error of 2% for the fund. Majdi Chammas, Head of External Management at AP1 acknowledged that this is relatively high, but says that – based on annualised outperformance of 2.2% over five years during back-testing – “we think we will perform better than the market in the end”.
“We want to achieve at least market returns over three to five years. We decided we could do that and still achieve meaningful ESG impact by going to a 2% tracking error, and that was in BlackRock’s comfort zone too.”
Both Rönnholm and Chammas agreed they “would love to move all the emerging markets capital away from passive strategies”.
“We’re asset owners, so we should talk less about overall benchmarks and more about avoiding loss of capital,” – AP1’s Tina Rönnholm
“We’re asset owners, so we should talk less about overall benchmarks and more about avoiding loss of capital,” claimed Rönnholm. “The benchmark we have in emerging markets currently has a huge concentration in Asian financials and tech stocks, which illustrates that being close to a benchmark does not in any way make you risk free. So we welcome deviation from the benchmark.”
Chammas also pointed out that moving away from passive would remove the reputational risks to AP1 of holding controversial companies via an index.
The $100m that has been allocated to the fund was already run by BlackRock under a conventional passive strategy. AP1 plans to allocate “a substantial amount” to the fund over time, subject to ongoing monitoring and performance. But it also wants to find other asset managers, for the sake of diversification.
“Anybody who can come up with a solution for this challenge, we want to speak to – we’re just at the beginning of this process,” Rönnholm adding that AP1 is already considering a second solution from an undisclosed asset manager.
“The industry should be doing this everywhere – not just in emerging markets,” she said. “This is our duty because we have a seat at the table. We need to push sustainable investing. We could have this discussion with every asset manager in the world, if we choose to.”
The launch comes just a day after investment veteran Mark Mobius announced the launch of a new asset management house focused on ESG in emerging markets. The firm will take an active equities approach.