The numbers continue to amaze.
ESG (Environment/Social/Governance) seems to be everywhere in the investment world.
84% of flows into global equities in the past 2 years were into ESG funds according to one source. And there is no slackening in the pace – flows in the last 4 months of 2020 were better than the previous 20 months combined.
The pandemic has lit a fire under these investment trends.
And ESG is performing well.
2020 was a blow-out year for the S&P 500, but ESG funds did even better. Looking at the numbers for those firms who run both ESG and Non-ESG mandates confirms superior performance from the ESG mandates over 1 , 3 and 5 year time periods. This is a key part of the marketing message – you can invest on a sustainable basis without foregoing return.
ESG is likely at the top of every marketing budget, every fund launch calendar, every business development meeting agenda at major asset management companies globally.
It’s clear there is both a response to demand and a creation of demand.
ESG can be quite a complex space for investors to navigate, an alphabet soup of acronyms being added to on a regular basis. Added to this is the fact that ESG approaches vary considerably among asset managers.
In February, the Central Bank of Ireland clearly laid out the risks in such a landscape where “strong investor demand is met by products purporting to be sustainable in nature but do not meet standards”. This is a global concern for regulators – the FCA in the UK expressed similar views. The FCA said they will be focussed on the development and integrity of the ESG market and will examine ratings as well as qualifications.
There are a few things investors should look to in considering their ESG options.
Examine the fund’s track record. There have been a few undercurrents in stock-market sector performance which have played to ESG mandates favour in recent years. Many ESG funds would be underweight or not invested at all in fossil fuels. This has been very beneficial, as the energy sector has been weak due to slower economies and pricing ill-discipline. This could reverse. Also many ESG funds have found themselves overweight in sectors such as technology, which have good ESG scores and have also enjoyed phenomenal performance, partly driven by Covid circumstances. These high growth sectors may be compromised if interest rates were to rise meaningfully.
Also what period does the performance track record cover? It is important to point out that while many of the ESG labelled funds are new, some are simply a rebranding of already existing funds. According to Morningstar, over half of ESG funds were already in existence but have now been converted to sustainable funds. This is important for a number of reasons. Firstly just how much a re-engineering of process etc. has really taken place? Also it means we may need to be careful in looking at the performance track record that the asset management company is showing.
The majority of ESG funds globally are actively managed. In this space active is about 4 times larger than passive strategies.
It is vital to look at exactly what the fund manager is doing within their ESG process. Are they really engaging with companies on ESG issues and voting at AGMs? Recent surveys have suggested that some of the larger asset managers are less pro-active than they portray. And what about how investments get rated? Are they simply relying on third party ESG scores or do they have an integrated ESG framework and in-house expertise. Regulators have cautioned against managers mechanistically following third party ratings providers. There are often inconsistencies as ratings providers have been known to rate companies differently.
Important to look, as well, at the resources allocated to ESG within the asset management firm. What percentage of full time employees have they allocated specifically to their ESG endeavours? For large European asset managers this currently ranges between 1 and 4%.
Questions around integrated investment process and numbers of FTEs working on ESG, are really about commitment and conviction, Both these factors appear linked to superior investment performance.
The European Commission has established an action plan on sustainable growth investment. The most recent instalment being the SFDR guidelines. These will require fuller disclosure of the degree to which ESG factors bear on the investment outcome. Hopefully this should help crystalise many of the issues for those considering investment.
Tradewinds 