Q&A WITH JANUS HENDERSON

This week we sit down with Nick Cherney at Janus Henderson to discuss the company’s recent active ESG launches and how the active ETF market is evolving.

Janus Henderson’s active ETF suite now includes nine ETFs across both equity and fixed income with more than $4 billion in AUM, including the recent addition of five NYSE Arca-listed sustainability-oriented ETFs (JIB, SCRD, SXUS, JZRO & SSPX). How has the active ETF market evolved and what tailwinds/headwinds do you see on the horizon?

Only a few months ago I predicted that Global Active ETF assets would surpass $1 trillion in 2025. Already, that prediction seems conservative.

When ETFs were first introduced 30 years ago, they were synonymous with passive investing, and many of the early adopters were not just choosing ETFs, but abandoning active management. In fact, the earliest ETF sponsors adopted a distribution strategy targeting advisors and retail investors with a story of passive management vs. active management. Since then, ETFs have become a tool of choice for active managers, whether individual investors or large global institutions that are seeking the most efficient means to implement their active portfolio construction.

So, while some in the asset management industry have clung to the idea that ETF is synonymous with passive, the investing public severed that link a long time ago. Today, meme stocks and cryptocurrencies seem to rule the financial headlines, and these stories fly directly in the face of a narrative that investors don’t believe in active management. No one is building market cap weighted portfolios of GameStop or bitcoin. But underlying these stories is something perhaps more interesting, which is a resurgence of interest in investing and trading, disintermediated, available immediately.

The last 20 years of technological change have led consumers to expect infinite variety, instant availability, and all at extremely low cost. In the world of investing, ETFs provide this sort of choice, and have come to represent for many investors -- particularly younger investors -- not a question of active vs. passive, but of modernity vs. an archaic financial system. The reality is obviously more complex, and we firmly believe each fund structure has its valid purpose, in fact 88% of US households that own ETFs also own traditional mutual funds, but the cultural shift among the investing public seems undeniable. Some might attribute that sentiment entirely to retail investors, and while only 30% of US high-net-worth investors are self-directed, these same forces are affecting financial advisors and institutions as well, and many have come to see ETFs as the future of asset management.

So, my thesis is that ETF popularity will only continue to increase, not only because of the structural benefits of the product in terms of trading, transparency, tax efficiency, and low cost, but also because of the larger cultural zeitgeist to simply view ETFs as the modern improvement on the traditional open-ended fund. When viewed through this lens, the growth of Active ETFs is not so much about the active, but rather that the passive ETF universe is largely complete, and more and more active managers will continue to offer their services in this wrapper.

Why did you decide on the ETF wrapper for your sustainable ETFs? And why actively managed?

While we have offered our flagship ESG strategy, Global Sustainable Equity, for over 30 years now, we have never had a large product platform for ESG products in the US. It was important for us to try and bring the full range of our investment capability in this area to bear so that our US clients could access strategies across many of the major exposures in their portfolios. So, for us the need for a product launch was quite clear, and the decision on which wrapper to deliver was probably equally clear.

While ETFs currently represent only around $175 billion of the global ESG products landscape -- so less than 10% -- investors have been increasingly voting with their dollars, particularly for new fund launches, and expressed a preference generally for the ETF wrapper. Our job is to deliver risk-adjusted returns to our clients, and if we can do that in a wrapper they increasingly prefer, that is where we are going to go. Obviously, many of our clients still actively invest in and, in some cases, prefer traditional mutual funds, and we continue to create product offerings there, including a US mutual fund based on our Global Sustainable Equity strategy. But we see the trend towards ETFs accelerating, and by and large for new product development in the US, it is where our focus has been.

As far as active vs. passive in ESG, we don’t believe fundamentally that a passive product can holistically deliver what ESG investors are looking for, beyond a label. Passive ESG can simply mean negative screening for companies that don’t score well on certain ESG quantitative factors. Any Active ETF should incorporate a similar process as step one, but it is very important to go well beyond that. ESG-related issues can be exceedingly complex, and it takes a lot of hands-on analysis and judgment to sort through those issues.

For example, an ESG fund would typically screen out a company that uses thermal coal in its electricity supply chain. But what if there is a market-leading company that is positively impacting the way a certain industry affects environmental and social issues, and they are located somewhere where the entire energy grid relies on thermal coal? Should that company be excluded or supported? That is a very nuanced and complex question that we believe requires active decision making.

Then, of course, the whole issue of engagement is very significant. Not just engagement with corporate management and boards, but also with, for example, federal mortgage agencies and thinking about how to improve credit provision to minority and low-income communities. These are the types of things that are just left off the table with a passive approach.

What trends do you see in the U.S. that prompt sustainable/ESG ETFs or sustainable investing?

While there are a lot of interesting US-specific things going on within asset management and wealth management in particular, these changes are being driven by broader societal pressures and awareness. ESG investing is nothing new, from institutional accounts divesting from South Africa in the 1980s, to the creation of the United Nations Principles for Responsible Investment in 2006, to which Janus Henderson was an original signatory.

What has really created a sea change over the last few years, however, are two major factors. The first is that awareness of these issues is becoming mainstream. Outside of the realm of investments, many topics of importance to ESG investors have taken a front-line position in our national discourse. This means that from investment committees to individual investors, many are seriously thinking about how to address sustainability, social equity, and many other such issues within their portfolios.

The second, and perhaps more significant shift, has been the increasing realization that ESG does not have to represent a tradeoff between doing good and doing well. That in fact robust, market-beating portfolios can be built while also addressing ESG considerations. As investors look seriously at how their portfolio is built through an ESG lens, and then come to realize that there does not need to be a tradeoff vs. returns, the adoption of ESG strategies should only increase.

What are the key considerations for investors who are contemplating actively managed ESG ETFs?

Like any other investment choice, there can be a wide range of complex issues to consider when selecting an ESG ETF. In our mind, the two key elements in this case are first: Does the ETF actually accomplish the sustainability or other objectives it purports too? And second: Can the strategy deliver the investment results you expect?

In our view, this first point is one that is often completely missed by passive ESG solutions. Really, they are just exclusionary lists for the most part, similar to phase one ESG investing in the 80s, with simple divestment strategies. While divestment can be an important tool, we view this as only the most basic and elemental step in the process. From there, it is critical to have a strategy that understands and addresses the many, many nuanced issues surrounding ESG investing. For example, should a steel company be excluded, or should we be proactively investing in industry leaders in green steel that are making a more environmentally responsible future possible?

Should the portfolio managers of ESG funds simply follow basic third-party instructions on which companies to own? Or should they proactively engage with management teams at the companies they invest in, and seek to drive further change? There are countless examples and nuances that require a lot of intention from portfolio managers, and we think this is probably the first thing ESG investors need to determine for themselves: Can passive really deliver on ESG expectations?

Then the second piece is: Can the fund find the nexus of good companies, and good investment results? There are countless non-profits all over the world doing incredible work on issues of importance to ESG investors. But, just like those non-profits, many public companies that are doing good do not present a compelling investment opportunity in the short to medium term, and it is important that funds are seeking that intersection of good companies and good investment results.

By introducing five actively managed ETFs, you nearly doubled the JHI ETF lineup. What drove your decision-making in bringing a complete suite of ETFs to market?

This goes back to some of the prior discussion here, which is that we see a substantial shift over the coming years of investors really seriously looking at how they incorporate ESG into their portfolios. And when they do that, one of the issues they will face is ensuring they have a complete tool set, across asset classes, that can really deliver on the key issues they face.

While five ETFs is far from covering the total universe, we wanted to fill as many of the big buckets as possible. So the suite provides both US and international equity, core fixed income and corporate credit, and then one thematic product that addresses one of the most significant trends in not just ESG investing, but we believe, in future state capital markets generally, and that is the global transition to net zero. We want our clients to know we are serious about this space and that we are ready to deliver them solutions across their entire portfolio construction process. If the future evolves as we think it will, five ETFs will seem like a small initial offering.

Sources:

Brown Brothers Harriman, as of March 8, 2021

Investment Company Institute, as of March 2021

The GlobeNewswire, as of Oct, 19 2020

PwC, as of March 2020

All investments contain risk and may lose value. This material contains the current opinions of the manager and such opinions are subject to change without notice. Janus Henderson is not affiliated with NYSE.

Source: Factset & NYSE Internal Database and Consolidated Tape Statistics as of 11/5/2021

*Simple average

Source: Factset & NYSE Internal Database and Consolidated Tape Statistics as of 11/5/2021

*Simple average

Source: Factset as of 11/5/2021