Exchange-traded funds (ETFs) are developing into an important instrument for institutional investors who wish to include environmental, social, and governance (ESG) criteria in their portfolios. According to insurance experts, insurers in particular can benefit from ESG ETFs. Exchange-traded funds offer them a combination of strict compliance with regulatory requirements, flexibility in asset allocation, and fine-tuning of their ESG strategy. This also enables the implementation of self-indexing strategies.
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Sustainable ETFs proved that they can generate additional returns in a difficult environment
As Invesco experts noted, some large institutional investors – including insurance companies – have already switched their entire ETF portfolio to ESG strategies, with the COVID-19 crisis and the market volatility that has triggered further accelerating the trend towards ESG ETFs.
Christina Volkmann, Head of Insurance Solutions at Invesco Germany, sees fundamental structural reasons for the increasing attractiveness of ESG ETFs for insurers. In the first place, she mentioned regulatory developments and the inherent qualities of ETFs such as transparency, flexibility and low costs. “Our impression is that insurers no longer see ESG as a limitation, but as an opportunity. This is also reflected in the fact that many insurers have gone beyond the regulatory requirements when integrating the ESG dimension,” said Volkmann.
In their view, this may already have paid off, as ESG strategies have clearly demonstrated their ability to reduce risk in turbulent markets – a key objective for insurers – in recent years. “In the long term, the ESG approach can contribute to a gradual reduction of risk by mitigating, for example, fraud, climate and pandemic risks,” Volkmann explained. In the turbulent first quarter of 2020, sustainable ETFs proved that they can generate additional returns in a difficult environment: According to Morningstar, 24 out of 26 ESG ETFs outperformed non-sustainable competing products during this period.
As Volkmann explained, the outperformance of ESG funds is partly due to their lower exposure to the energy sector. Ultimately, however, resilience is a fundamental characteristic of these funds, which is often due to their crisis-proof sector allocation strategies. “This investment philosophy naturally avoids oil, for example, and gives preference to health. This characteristic gives insurers a natural ally in their particularly prudent risk management approach,” Volkmann said.
Meanwhile, the issue of ESG is also making massive inroads into the regulatory frameworks for European insurance companies
The European Union’s new ESG reporting framework (Sustainable Finance Disclosure Regulation, SFDR), which comes into force on March 10th, 2021, obliges insurers based in the EU to publish detailed strategies for taking ESG criteria into account on their website in future. In addition, life insurers and all companies that offer insurance-based investment products will be required to disclose in their pre-contractual documentation for customers how they take ESG risks into account and what impact this has on the value and performance of their investments.
Moreover, insurance companies with more than 500 employees will need to disclose their strategies for managing the negative ESG impact of their investments. These insurers will also be subject to the Non-Financial Reporting Directive, which will soon require them to disclose what proportion of their investments fund “green” activities as defined by the EU taxonomy. The EU taxonomy defines sectors with positive environmental impacts.
In addition to regulatory pressure, the inherent characteristics of ETFs are attracting more and more insurers to ESG ETFs
First, ETFs are transparent, easy to understand products that are very accessible to investors. “Their user-friendliness is an asset for insurers who are willing to test new or complementary strategies,” said Volkmann. Insurers also value ETFs as flexible and liquid products. “As we have seen in this crisis, ETFs remained liquid and continued to be traded even under the most difficult conditions investors have ever experienced – both in the primary and secondary market,” Volkmann emphasized. “In the eyes of many investors, the flexibility of the products and the ability to buy or sell them at any time in an extremely volatile environment seem to have made ETFs even more attractive.”
An important plus point for insurers and investors in general is the cost-effective structure, which allows easy ESG optimization of asset allocation using ETFs – a major advantage in a crisis environment where cost awareness is particularly pronounced. Volkmann concluded: “The ETF format is particularly well suited for implementing advanced ESG strategies tailored to the individual needs of each insurer. We refer to this as ‘self indexation’, the aim being to create an index that reflects the ESG requirements and strategies of the institution in question, as ESG approaches continue to vary widely in the absence of a uniform market standard.”
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