Analysis-Vanguard's climate group exit shows retail investors trail on ESG

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By Ross Kerber and Tommy Wilkes

(Reuters) - Vanguard Group's decision last month to quit a key climate change coalition underscores how the retail investors who dominate its client base focus less on environmental, social and corporate governance (ESG) priorities than institutional investors. Vanguard said last month it would drop out of the Net Zero Asset Managers (NZAM) initiative, whose members commit to making their investment portfolios emission-neutral by 2050. It said 80% of its close to $8 trillion in assets are in its index funds, which primarily attract retail investors. These funds generally do not have discretion to include or exclude stocks beyond a pre-set mandate, and most do not account for carbon emissions. Vanguard did not explain what changed since 2021, when it joined NZAM, but said it was responding to a desire of its clients to provide "clarity" and make its independence clear. Vanguard's biggest competitors, BlackRock Inc (NYSE:BLK) and State Street Corp (NYSE:STT)'s asset-management arm, rely more on institutional investors including pension funds and foundations. Both BlackRock and State Street have stuck with NZAM. At BlackRock and State Street, mutual funds and exchange-traded funds - the investment vehicles popular with retail investors that include many types of index funds - account for around 41% and 30% of assets, respectively, according to data from Morningstar Direct and company disclosures. At Vanguard, that figure is 88%. Institutional investors focus more on climate and other ESG priorities amid pressure to do so by clients, regulators and investment activists, said Todd Rosenbluth, head of research at ETF data and analytics provider VettaFi. "BlackRock and State Street are appealing to an investment base that cares more about ESG," he said. Many retail investors are also interested in matters like climate change, but prioritize them less in building retirement portfolios, said Rosenbluth and other industry analysts.

A FINRA Investor Education Foundation study of retail investors last March found only 9% of respondents held ESG investments. This is despite 57% of them saying they thought ESG investing can lead to positive change in the world. A big factor behind this gap is retail investors' lack of familiarity or knowledge about ESG products, the study found.

Neil Bathon, managing partner of funds researcher FUSE Research Network, said obscure and inconsistent ESG ratings also make it hard for individuals to understand the value of ESG investing, especially after a fall-off in tech stocks and rising oil prices last year hurt returns in ESG funds. For many individuals, "it's very difficult to trace investment to impact" on environmental or social matters, Bathon said.

Vanguard's NZAM participation was modest to begin with. It said 4% of its assets would be aligned by 2030 with a goal of net-zero emissions, compared with State Street committing 14% of its assets. BlackRock has said it expects more than half its assets to meet the 2030 target, but it has not made a firm commitment. "You wonder why Vanguard signed up in the first place," said Hortense Bioy, global director of sustainability research at fund ratings firm Morningstar Inc. Vanguard representatives said the company looks forward to continuing constructive conversations with policymakers. A BlackRock spokesperson said it "has a large and diverse client base with a range of investment goals" and that as a fiduciary, "our only agenda is delivering the best financial results.” State Street declined to comment. ESG BACKLASH Kirsten Spalding, vice president at sustainability nonprofit Ceres, a founding partner of NZAM, said she believed that Vanguard's move was mainly in response to a backlash against ESG from Republican politicians. Vanguard's NZAM withdrawal spared it from appearing at a Dec. 15 Texas hearing where BlackRock and State Street executives were grilled about their participation in NZAM and other ESG initiatives. State Street Executive Vice President Lori Heinel said during the hearing the firm must do some "delicate threading" to account for a wide range of views held by clients globally.

Among the BlackRock and State Street institutional clients putting a higher priority on ESG would be European asset owners and big U.S. pension funds run by Democratic officials.

One is New York City Comptroller Brad Lander, who oversees some $41 billion of city assets managed by BlackRock, $31 billion managed by State Street, and none by Vanguard. "We have made this commitment to net zero carbon and we can't achieve it unless our asset managers are aligned with it," Lander said. Vanguard's exit from NZAM has not fully spared it from the ESG backlash. A coalition of 13 Republican state attorneys general are pressing on with a motion asking federal energy regulators to limit Vanguard's ability to invest in public utilities.

Representatives of several attorneys general declined to comment on what impact Vanguard's NZAM departure may have on the motion.