ESG funds recover strongly, hitting $1 trillion

Electric mobility ventures stand to benefit the most from green EU investments.

For a long time, it was difficult to establish whether sustainable investing was simply a branding initiative or a viable trend. After three years of steady capital inflows into the market, that is no longer the case.

In the second quarter, sustainable funds rebounded strongly from the coronavirus market sell-off, supported both by the stock market recovery and growing investor interest in environmental, social and governance (ESG) issues.

Global inflows into sustainable funds were up 72% in the second quarter of the year, according to a Morningstar report.

The rating agency found that assets in sustainable funds hit a record high of US$1.06 trillion at the end of June, up 23% from the previous quarter.

The heightened interest in sustainable investing is fuelling the continued development of new products. In the second quarter alone, 125 new fund offerings were launched. And asset managers continued to rebrand conventional products into sustainable funds, the report said, counting 40 such funds in Europe and three in the US.

Europe is the dominant, most developed and most diverse market for sustainable funds. Of the 3,432 open-end funds and exchange-traded funds globally that use ESG criteria as part of their security selection, 2,703 are European, accounting for $870 billion in assets. In the second quarter, European funds also attracted almost 86% of global capital inflows.

The European dominance is, in part, a reflection of the political landscape and the European Union’s willingness to invest in sustainable industries. The EU’s coronavirus-relief package and its Green Deal, passed in January, will pour about EUR1.23 trillion into sustainable investments.

Electric mobility, energy-efficient upgrades to commercial and residential buildings, water infrastructure and renewable-energy generation all stand to benefit, a report by Ambienta, a European asset manager focussed on sustainability shows. However, these investments will not even cover one-third of what would be needed to meet the EU’s 2030 climate goals. The remainder would have to come from private investors or EU member states.

In the US, large pension funds like Calpers have been at the forefront of investor-led initiatives like Climate Action 100+ to push large CO2 emitters and polluters to set emission targets, make climate-related financial disclosures and ensure boards are focussed on climate issues.

The perception that capitalism is not working for everyone is further leading to investor groups calling for companies to be evaluated against workforce issues, including diversity policies, gender pay and employee turnover rates.

One issue holding the ESG movement back is the lack of standardised metrics. As investors have shown interest in taking environmental, social and governance factors into account, measuring these intangible concepts consistently still presents a challenge.

Companies meanwhile are complaining that they are struggling with the various rating systems they are faced with.

Lady Lynn Forester de Rothschild, founder of the Coalition for Inclusive Capitalism and a director of Estee Lauder, told the Financial Times that the cosmetics company’s sustainability office was grappling with the many different investor questionnaires.

“Currently, over 150 ratings systems exist, covering over 10,000 sustainability performance metrics, that are trying to fill in the gap that is left by the lack of a generally accepted standard,” she said.

Two of the main industry standard setters, the Sustainability Accounting Standards Board and the Global Reporting Initiative, announced a new attempt at collaboration to help stakeholders understand how both of their standards could be used in practice.

None of the standardisation issues are likely to dampen the interest in sustainable investing. By now, numerous studies have shown that ESG strategies tend to outperform comparable alternatives.

A Morningstar study earlier this year found close to six out of 10 sustainable funds delivered higher returns than equivalent conventional funds. The study, based on a sample of 745 European sustainable funds, showed the strategies did better than non-ESG funds over one, three, five and 10 years.

The level of outperformance depended on the asset class, with US large-cap blend equity funds that invested sustainably showing the highest returns over traditional peers over a 10-year period.

While some have argued that much of the better returns are the result of lower exposure to oil and gas stocks at a time when they are performing poorly, there are also other factors at play.

According to asset manager BlackRock, one overlooked reason is better supply-chain management and corporate governance.

In order to score highly in ESG ratings, companies typically have to assess their supply chains and employment practices. For many companies, supply chains are not only an area where many potential improvements are hidden, for example in terms of lowering CO2 emissions. The audits themselves often yield information that leads to a better understanding and greater resilience of the organisation as a whole.

Support local journalism. Subscribe to the all-access pass for the Cayman Compass.

Subscribe now