Investment News & Views

Is the growing interest in ESG investments another bubble?

According to figures from the Investment Association, sustainable investment funds witnessed a record level of demand over the first three quarters of 2020, with more than £7bn invested into mandates seeking to have a positive impact on the world. To put this growth into context, over the same three quarters last year, the total amount invested into the space was £1.9bn. The recent momentum observed in ESG investing is remarkable. Once a niche, ESG investing is fast growing in every region of the world and assets indicated as following ESG principles may soon represent 44% of global AUM.

So, what is driving this growth in interest in sustainable investing?

One reason is likely to be the radical impact COVID-19 has had on global economies in such a short space of time. Many investors are viewing the Covid-19 crisis as a wake-up call that accelerates the need for a different approach to investing as parallels have been drawn between the unforeseen risks of a pandemic and issues such as climate change.

According to analysis by Blackrock, 88 percent of sustainable funds outperformed their non-sustainable counterparts in the period 1 January to 30 April 2020.1 They also examined whether this effect remained after the market recovery that began in late March of 2020 and found that the resilience was persistent. 88% of these sustainable funds outperformed their non-sustainable counterparts from January 1, 2020 through April 30, 2020. Blackrock also looked at whether this resilience for sustainable funds is found in earlier periods of market turbulence. They examined a – set of 32 sustainable indices along with their non-sustainable benchmarks back to 2015. They found that during notable market downturns in 2015-2016 and 2018, sustainable indices tended to outperform their non-sustainable counterparts – that is they demonstrated a smaller drawdown during the market downturn.

We can see this clearly with the equity ESG funds used in Crossing Point Green Path portfolios. The following charts compare the performance of the ESG funds compared to a non-sustainable index benchmark over the last year for the US, UK, Emerging Markets and Japan. They each show the outperformance of the ESG funds since the market dip in March 2020.

Chart 1: Performance of ishares MSCI USA SRI ETF over the 2020 Covid-19 crisis

Performance of ishares MSCI USA SRI ETF over the 2020 Covid-19 crisis

Chart 2: Performance of UBS MSCI UK IMI SRI ETF over the 2020 Covid-19 crisis

Performance of UBS MSCI UK IMI SRI ETF over the 2020 Covid-19 crisis

Chart 3: Performance of ishares MSCI USA SRI ETF over the 2020 Covid-19 crisis

Performance of ishares MSCI USA SRI ETF over the 2020 Covid-19 crisis

Chart 4: Performance of Stewart Investors Global EM Sustainability over the 2020 Covid-19 crisis

Performance of Stewart Investors Global EM Sustainability over the 2020 Covid-19 crisis

So why might sustainable funds be outperforming their non-sustainable counterparts?

Could it be explained by the fact that non-sustainable funds tend to include traditional energy companies and these have not performed well in recent years? Research by Morningstar2 finds the resilience in sustainable assets is more than just an “energy story”— in other words, the severe downturn in energy stocks only explains a fraction of the strong performance of ESG funds. They examined 26 sustainable funds and found that the absence of traditional energy companies contributed an average of 43 basis points (bps) of outperformance in U.S. funds, 28 bps in ex-U.S. developed markets, and 24 bps in emerging markets funds. But they found an even greater overall effect from “stock selection” – i.e., the higher exposure of these funds to more sustainable companies. The impact of this higher exposure was just as important as energy in the U.S. (contributing 45 bps of outperformance) and was significantly stronger in developed markets outside the U.S. (144 bps) and emerging markets (105 bps).

What is driving this outperformance by sustainable companies?

Blackrock find that outperformance by companies is driven by good scores for sustainability factors such as board effectiveness, use of clean technology, and energy management. They concluded from their analysis that investing with exposure to sustainability factors can lead to better risk-adjusted returns over the long term.

Indeed, the evidence is now so striking that Al Gore, the former US vice-president, told the FT3 that “investors who do not recognise this new reality . . . are in serious danger of violating their fiduciary responsibility to their clients by leaving money on the table, and not taking into account factors that can actually improve performance of companies.”

What makes us confident that this demand for sustainable investments will continue?

An important factor here is the outcome of the recent US election. At the time of writing, Joe Biden has been declared the US President-Elect and one of his first priorities will be to re-join the Paris Agreement, an international climate-accord adopted in December 2015. In addition, he has set out an ambitious climate agenda. With $2trn in federal investment, Biden aims to achieve three goals: create jobs, modernise critical infrastructure and support the growth of green technologies.

The UK government has also committed to build back green following the Covid-19 pandemic. A 10-point plan was published on 18th November 2020 which, among other things, brings forward the ban on petrol and diesel cars to 2030. The UK Chancellor has also announced in November that the UK will become the first country in the world to make a Task Force on Climate-related Financial Disclosures (TCFD) fully mandatory across the economy by 2025, going beyond the ‘comply or explain’ approach. He also announced the UK government will issue its first sovereign green bond in 2021.

References

1 https://www.blackrock.com/corporate/literature/investor-education/sustainable-investing-resilience.pdf

2 https://www.morningstar.com/articles/976361/sustainable-funds-weather-the-first-quarter-better-than-conventional-funds

3 https://www.ft.com/content/87e2a2d2-a7be-4a97-bc7c-33211c9d6329

  • Friday, December 4, 2020

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author

Professor Mike Buckle

Investment Officer

Mike chairs Crossing Point’s Investment Management Committee and holds the CII Certificate in Discretionary Investment Management.