How has ESG become the height of fashion? Kyle Caldwell names three factors at play.
Investor appetite for funds that invest in a socially responsible fashion has never been higher, with the latest figures from global funds network Calastone showing that year-to-date (up to the end of September) ESG equity funds have attracted £2.4 billion from investors.
To put this figure into context, equity funds of all kinds have seen a total of £2.9 billion invested over this same period.
Over the third quarter, £1 billion was invested in ESG funds (those that apply environmental, social, and governance criteria), which Calastone notes is almost 10 times as much as the third quarter of 2019.
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So what has triggered the transition of ESG investments from the wilderness to the height of fashion? Here are three factors at play.
Millennials have the ESG investing bug
While sustainable investing has become more popular among all age groups to align investments with personal values, demand from millennials is a driver behind the increased appetite for ESG funds.
Numerous studies and surveys have pointed to this trend. MSCI, the index provider, noted in a research report in March: “In recent years, adoption of ESG investing has accelerated in part due to momentum from key industry organisations, such as the Principles for Responsible Investment (PRI), availability of better ESG data and tools, and demand from the next generation of investors known as millennials.”
MSCI adds that the studies and surveys it analysed “suggested that millennials, as well as women and, increasingly, individual investors of all ages and genders, are interested in directing their investments toward companies with good ESG records. This reflects a desire for their money not just to earn a return, but to align with their personal values and contribute to the social good.”
In addition, millennials are less likely to sacrifice personal beliefs for financial gain than other generations, according to Schroders’ Global Investor Study 2020. The study, which polled more than 23,000 people around the world, found only one in five of the under-30s would compromise on ethics for high returns
Overall, the study found that age had a strong bearing on the chance of investors deviating from their morals to make more money. Some 50% of Brits aged over 71 would trade their personal beliefs for higher returns, as would around 23% of baby boomers and 22% of those born in the 1970s, classed as Generation X.
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Another key driver is the shift in a previously deeply entrenched view that returns must be sacrificed to invest ethically or sustainably.
One recent piece of research that adds weight to the evidence that investing ethically or sustainably enhances returns rather than detracting from them came from Moneyfacts.
The firm examined the performance of ethical funds versus conventional non-ethical funds over a number of investment periods across the four Investment Association (IA) sectors that contain the most ethical funds (£ Corporate Bond, Global, Mixed Investment 40-85% Shares and UK All Companies).
The research found that ethical funds outperformed their conventional rivals in 19 out of the 25 scenarios analysed, across a range of investment periods.
Elsewhere, interactive investors’ original ACE 30 list of ethical investments, which has recently been expanded to the ACE 40, demonstrated strong performance in its first year (the list was launched in October 2019). A total of 70% of the funds were in the first quartile (top 25% of funds) and second quartile (outperforming the median fund return) of their respective sectors since launch.
More choice for investors
Fund management groups have latched on to the ESG trend, with a wave of new fund launches in 2020, both actively managed and passively managed funds.
More choice is undoubtedly welcome, given that the ethical investment sector is an immature market.
However, investors need to watch out for potential “greenwashing”. This is when asset managers push themselves or their funds as “green” through marketing, rather than fully integrating ESG and sustainability into their investment processes.
Potential greenwashing is hard to spot, but one tactic that may help in identifying it is to assess the fund manager’s heritage in the ESG sector, as well as the fund management group’s overall knowledge and experience.
According to Edward Glyn, head of global markets at Calastone, actively managed ESG funds “have an opportunity to land some punches” in the battle for investors’ cash versus passively managed ESG funds.
In theory, a fund manager can add more value on the ESG front by challenging management to improve their ESG characteristics, in order to have a more positive impact on the planet. In turn, this could lead to improvements in the operational and financial performance of the businesses held by the fund.
Given that active fund managers have been losing market share to passive funds over the past decade, ESG offers the chance to add value both in terms of making a direct impact on society and delivering outperformance.
Glyn says: “By pivoting to ESG funds, [fund managers] are not only capturing the zeitgeist, but also bolstering their margins. There is enormous public interest as ESG goes mainstream, and active managers are able to differentiate these products much more effectively from passive funds, and they can charge premium fees as a result.”
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