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CA-EN Institutional

Marching to your own ESG drum – active, passive or both?

April 26, 2021
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Nalini Feuilloley, Jennifer So and Mark Raes share their insights on responsible investing (RI) for institutional investors – from setting up policy to implementing active and passive strategies that work for their individual approach.

Creating the right RI framework

With responsible investing (RI) becoming increasingly table stakes for institutional investors, it is important to set up the right investment framework and implementation strategies specific to the needs of the organization. What makes RI more challenging is that we all have our own values and views on what it constitutes, since the issues hit on a personal note – from climate change to Indigenous rights, to labour standards as just a few examples. What approach resonates for your firm? Is it mission-driven, exclusionary, or available across a broad investable universe?

A comprehensive RI framework starts by setting objectives, developing policy and then deciding what levers of RI approaches work for the plan. This can manifest in many ways, including integrating environmental, social and governance (ESG) factors into the investment decision-making process and ensuring it is part of the fundamental analysis of the companies in which you are invested. Taking this a step further, it is developing a due diligence plan for whomever is managing the assets, third-party or in-house, and holding them accountable for how and when ESG is being considered. For example, the framework could involve post-investment diligence, in terms of monitoring and engagement dialogue, particularly for pension plans who are answering to beneficiaries and want to ensure they’re not reducing their investable universe, and are taking a different leadership approach to propel change. Are the managers responsible for stewarding the assets engaging with investee companies to improve ESG business practices, and setting up plan beneficiaries for sustainable returns over the long term? Are they voting proxies to actually drive better performance instead of ticking the box to align with management recommendations? Finally, there is also portfolio construction to consider: for instance, how much will ESG factors drive the make up of funds?

As stewards of capital at the top of the investment chain, asset owners can push harder to accomplish more than table stakes, particularly when it comes to active ownership responsibilities. It is about driving change not only in how institutional investors construct their plan or portfolio, but at the actual investee company level – ensuring that their voices as shareholders are heard. Are fund managers working with an expert team to vote proxies on your behalf that are taking ESG risks and opportunities into account? What will be driving impact over the course of your investment?

As stewards of capital at the top of the investment chain, asset owners can push harder to accomplish more than table stakes.

The next step: A spectrum of implementation options

Once questions are answered and objectives defined, asset owners have the ability to select from a spectrum of innovative ESG-focused solutions to help achieve their goals, such as mutual funds, pooled funds, customized segregated accounts and/or ETFs. Since 2014, approximately $294 billion has been allocated by institutions to investments tracking MSCI ESG equity and fixed income indexes, indicating where the smart money is moving.1 They can now build entire RI portfolios or use satellites as appropriate – and address their unique needs. At BMO Global Asset Management, we firmly believe that active and passive strategies are complementary to each other, and this is no different for RI. It all depends on how an investor wants to approach the market.

For example, if tracking error is an issue, then an ESG-focused ETF would address that market return concern, more closely aligning to the benchmark. However, if there is an alpha sleeve and the institution can tolerate more tracking error, this is where an active strategy would come into play with a concentrated portfolio of leading ESG names. It is entirely about investor appetite, and there is often the opportunity to use both types of strategies hand-in-hand. That is why we offer BMO Sustainable Portfolios, which is an all-in-one managed solution that provides both ETF exposure and active funds that can help reduce overall ESG risk and generate outperformance. As one of the top-ranked most sustainably managed companies in the world1, we also have an entire suite of dedicated ESG ETFs across equities, fixed income and balanced solutions, and several RI funds, including BMO AM Responsible Global Equity Fund, BMO Sustainable Opportunities Canadian Equity Fund, and BMO Sustainable Opportunities Global Equity Fund.

Actively solving for sustainability

On the active side, we start by defining sustainability challenges, and we use the UN Sustainable Development Goals (SDGs) as a qualitative guide, looking for companies that actively align their solutions with these targets (from renewable energy to affordable housing). It’s moving beyond ESG integration which assesses how companies conduct themselves and the ESG factors they consider. How do their products and services contribute to a more sustainable world? Next, we assess whether we can tie the company’s current or future revenue to this theme, and if there is an opportunity to reduce costs. For example, can a company use less water or fuel and therefore improve its environmental footprint? If one or both answers to these questions is yes, then we know – over the medium and longer term – that there is a direct sustainable opportunity-linked path to increase margins, which translates into higher cash flow and earnings per share. Case in point: Descartes Systems benefits its own bottom line with a technology platform that helps businesses optimize the routes of delivery vehicles, maximize cargo utilization and reduce fuel use, with thousands of trucks removed from the road every year because of its software.

Our team seeks to fully recognize risks and to identify trailblazers like these that are capable of disruption through rigorous analysis – the companies that harness the intellectual property, technology, skill, scale and expertise to address these sustainability challenges and create long-term value in the process. We look for businesses with strong moats, that are led by visionary management teams who are asking what is the future going to look like, and how can I position my company to benefit? This is incredibly important, because we want businesses that can protect themselves, and can ensure the duration of this competitive advantage. What are the drivers of growth, and how achievable and predictive are they? It is a fusion of the fundamental framework, and putting relevant ESG data into context.

We start by defining sustainability challenges, and we use the UN Sustainable Development Goals (SDGs) as a qualitative guide, looking for companies that actively align their solutions with these targets.

ESG ETFs that represent the market and drive returns

Within our ESG ETFs, we take an inclusionary approach too by maintaining broad market exposure, while investing in ESG leaders. We accomplish this through our partnership with MSCI, the world’s largest provider of established ESG indexes and research that evaluates ESG factors by industry, with ratings of 7,500 companies and more than 650,000 equity and fixed income securities globally. Though some exclusionary screens are used to avoid controversial companies, the focus is on the selection of businesses with the best ESG footprint in each sector. Importantly for institutions, companies are compared on a meaningful, like-for-like basis (i.e., oil and gas firms are not compared to banks), which facilitates full market exposure, and maintains a lower tracking error because the ETF is deliberately built to represent the market. We are not simply selecting names that meet a certain threshold, but rather comparing the top-rated ESG enterprises at the sub-industry level based on key issues, with a 50% target representation per Global Industry Classification Standard (GICS) sector and sub-region relative to the parent index.

Importantly for institutions, companies are compared on a meaningful, like-for-like basis (i.e., oil and gas firms are not compared to banks), which facilitates full market exposure, and maintains a lower tracking error.

MSCI ESG Leaders Methodology

Sector Representation
Minimum ESG Rating
Minimum Controversy Score
Weighting Scheme
50% target sector representation per GICs sector and Sub-Region (to avoid regional and sector biases) relative to parent index
Excludes companies with ongoing, severe controversies
  • Market cap weighted
  • Rebalanced quarterly with ongoing, event-related maintenance
  • The following activities will use the “Least Restrictive” screen*: Alcohol, Gambling, Nuclear Power, Conventional Weapons
  • The following activities will use the “Moderately Restrictive” screen*: Civilian firearms, Tobacco
  • Nuclear Weapons will use the “Highly Restrictive” screen*
  • Controversial Weapons will use the “Most Restrictive” screen*
  • Companies involved in the mining of thermal coal, unconventional oil extraction, thermal coal-based power generation are also excluded

In BMO MSCI Global ESG Leaders Index ETF (Ticker: ESGG), for example, the method allows us to better address the misperception of having to sacrifice returns because we are investing across the investment universe globally. In fact, longer-dated ESG indexes exist to undermine this outdated argument further, with the MSCI World ESG Index Leaders Index generating higher returns over a 10-year performance period than its parent index (see table below).

MSCI’s rankings also include monitoring of ESG risks and regular updates of public documents and third-party data sets – from governments and NGOs – to minimize reliance on voluntary disclosure. On average per week, 180 companies are updated to account for new controversies, while 425 are changed to reflect new governance information, promising reliable data.

*As defined in the MSCI ESG Research Framework.

Performance: MSCI World ESG Leaders Index

1 year
3 year
5 year
10 year
MSCI World ESG Leaders Index (CAD)
MSCI World Index (CAD)

Source: MSCI Inc., March 31, 2021.

Catalyzing change as active shareholders

Across all our RI strategies, active ownership is a fundamental pillar, encouraging management teams and boards to improve long-term outcomes via both engagement and proxy voting. Our goal when we invest is to influence change through the relationship we build as an investor. Because we take a global approach, we have a clear view of different jurisdictions that are leaders on certain topics, and we will take those principles and apply them more broadly – levering the strengths of a 21-strong, specialist RI team that can help us identify emerging trends early on. As an example, one of our investee companies in the BMO Sustainable Opportunities Canadian Equity Fund, Canadian Natural Railway, recently made sweeping revisions to their board renewal process, adopting our recommendations after four years of direct dialogue, emphasizing a true partnership milestone for us. As asset managers, the task is to exercise our stewardship responsibilities and ensure companies are embracing the opportunity to create a better future.

BMO’s RI team achieved 343 milestones across E, S and G in 2020. To learn more, please view our Responsible Investment 2020 Review, where we detail the highlights and successes of our active ownership activities last year. 2021 marks   two decades since the start of our investor engagement program. The ongoing and constructive dialogue with companies on ESG issues enhances our ability to manage our clients’ portfolios, while serving as a direct path to creating positive impact for the environment and society.

Based on publicly available information, or press releases from 2014 to date.


This article is for information purposes. The information contained herein is not, and should not be construed as, investment, tax or legal advice to any party. Particular investments and/or trading strategies should be evaluated relative to the individual’s investment objectives and professional advice should be obtained with respect to any circumstance.

Any statement that necessarily depends on future events may be a forward-looking statement. Forward-looking statements are not guarantees of performance. They involve risks, uncertainties and assumptions. Although such statements are based on assumptions that are believed to be reasonable, there can be no assurance that actual results will not differ materially from expectations. Investors are cautioned not to rely unduly on any forward-looking statements. In connection with any forward-looking statements, investors should carefully consider the areas of risk described in the most recent simplified prospectus.

The viewpoints expressed by the Portfolio Manager represents their assessment of the markets at the time of publication. Those views are subject to change without notice at any time. The information provided herein does not constitute a solicitation of an offer to buy, or an offer to sell securities nor should the information be relied upon as investment advice. Past performance is no guarantee of future results. This communication is intended for informational purposes only.

BMO Global Asset Management is a brand name under which BMO Asset Management Inc. and BMO Investments Inc. operate. Certain of the products and services offered under the brand name, BMO Global Asset Management, are designed specifically for various categories of investors in Canada and may not be available to all investors. Products and services are only offered to investors in Canada in accordance with applicable laws and regulatory requirements.

®/™Registered trademarks/trademark of Bank of Montreal, used under licence.


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