Comparing ESG Scores Spring 2020 was a landmark quarter for Environmental, Social and Governance (ESG) fund sales with 76% of European fund inflows allocated to ESG tilted choices. This is way ahead of the US experience suggesting a divergence of investor preferences, with Europe leading the ESG charge.Yet securing analytical evidence for outperformance between funds claiming an ESG characteristic is more of a nuanced story. There are some studies showing outperformance whilst others show the opposite. With claims of ESG compliance mushrooming, it is worth probing the strength of the link between ESG performance, typically measured using scoring systems, and the equity performance.Over recent decades, there have been more than 2,000 empirical studies and several review studies on the relation betw…
Harold Macmillan, the UK Prime Minister between 1957 and 1963 was reputed to have replied “events dear boy” when asked what the most likely thing would be to knock his government off course. With the increased focus on Sustainable and Socially Responsible investing it now seems that there is significant “event risk” involved in running a company in contravention of these principles and the bigger and more high profile it is, the more dangerous things can get. The world seems more than ever eager to take offense. What would once be dismissed as a joke or mild criticism is now portrayed as something akin to assault, regardless of the intent behind the statement. The resignation of Alastair Stewart in recent days as a result of a (somewhat concocted) row on Twitter with another user is but one in a long list of the famous who have been brought low by controversy.
EBI’s ESG-integrated portfolios are now live. To mark the launch and in the run up to 2020, it’s an opportune moment to look back at the series of ESG blogs we have run over the last few months and to summarise the key takeaways for financial advisers.Firstly, demand for passive solutions is soaring. As previously mentioned, an ETFGI report found that global ESG ETFs/ETPs assets increased by almost 30% in 2018 ($7.6 billion in net new assets) whereas assets in equivalent non-ESG funds grew by less than 5% in the same period.Is ESG therefore a fad, with ETF providers jumping on the bandwagon? As we’ve discovered, there are ETFs for almost every whim nowadays – including a ‘vegan’ ETF which still has a heavy proportion invested in tech stocks.
The concept of “satellite and core” is a key discussion among financial advisers when it comes to portfolio construction. In essence, core investments make up a bigger proportion of long-term invested assets, and tend to be passive funds, while the satellite can perhaps include some riskier or more exotic active investments for the shorter term and tactical plays.This model is designed to lower costs, be more tax efficient, minimise volatility and provide some opportunity to outperform the markets – and it can be applied across investment vehicles, strategies, and asset classes. (Although it’s not to be confused with the typical way we talk about equities versus bonds – say, 60% for the former and 40% for the latter for a typical medium-risk portfolio – because both are typically longer term.) And this is where ESG comes in. So, do you hold ESG at the core or satellite?
Fund providers have an almost miraculous ability to create products that follow the news cycle. Index-linked funds (due to worries around inflation), robots and automation (robots taking over our jobs) and gender diversity ETFs (tapping in to Sheryl Sandberg’s ‘Lean In’ revolution). Gender diversity, hopefully, will be a lasting focus for investors, while internet-focused funds, which launched in the 1990s and early 2000s, had a seriously rocky start.No matter an investor’s principles and good intentions, ESG is prone to the same marketing whims and opportunism of fund providers as much as any other investment sector. And just like any other sector, ESG funds are also at risk of being overpriced, especially if a fund provider claims to launch a ‘first of its kind’ and therefore has no competition. ESG or not, a fund provider is a business, and its main aim is to profit.
Just like the debates around active versus passive funds or the definition of smart beta, the concept of environmental, social and governance-focused ETFs is hotly debated.ESG has come a long way. What started in the 1960s as stripping out tobacco stocks has evolved to other areas like gender equality, green bonds, social impact investing and more. ESG, to a certain extent, has also had to keep abreast of societal changes, removing increasing numbers of stocks and sectors as time goes on, from companies that derive most of their revenue from arms sales to companies that benefit from practices such as child labour.
One could argue that good ESG starts at home, and not just with a product range. As demand and awareness around environmental, social and governance factors grow, ETF providers are under increasing pressure to showcase their own good practices.Fund houses will also have to become more transparent on ESG, whether they like it or not. By 2020, the European Commission will require investment houses to disclose how they integrate ESG opportunities and risks into their processes to stop funds being labelled as ESG when they normally wouldn’t qualify – otherwise called ‘greenwashing’.
It is usually the case that any innovation or evolution in the ETF industry benefits equities first. Equity ETFs have launched in every category, from the smallest corners of the globe in terms of geography to smart beta and beyond. Fixed income and other asset classes, on the other hand, always take longer to achieve the same level of progress.ESG is no exception. Data from Morningstar as of July this year shows the vast bulk of assets and number of funds relating to ESG investment in Europe is in equities. In fact, there are only eight so-called sustainable bond ETFs in the region. There are currently only three providers offering these fixed income funds – db x-trackers, iShares and UBS, and their products are mostly invested in corporate bonds.