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Investors embrace ESG funds during the crisis; is passive set to be massive?

September 2020

Categories: DIY Magazine

Possibly stung into action by a growing sense of the planet’s fragility, investors poured record sums into sustainable investment funds that invest according to environmental, social and governance (ESG) principles during lockdown – writes Tabitha James.

According to research and data giant Morningstar, over $70bn was invested in ESG funds globally between April and June taking total assets under management above $1tn for the first time.

Further data from fund network Calastone suggested that more money was invested in ESG funds in the second quarter of this year than in the past five years combined.

Such figures should be music to the ears of the active managers that have been battered by the flight of capital into passive products, but there is some evidence that trend may continue with sustainable investments.

Sustainable funds’ market share is still small, given the $41tn held by all investment funds worldwide, but growing public awareness of the climate crisis is rapidly boosting sales of ESG funds; the shock delivered by the coronavirus has accelerated the sector’s growth as investors seek out sustainable businesses that are resilient to market shocks.

In announcing its figures Calastone’s head of global markets, Edward Glyn said: ‘From 2015 to 2017, little or no new money was invested in ESG funds, but real momentum has been building in the last two years in the appetite for investment products that align with savers’ ethical concerns.’

Mr Glyn noted that demand for sustainable investing was increasing before the pandemic, but said that the crisis had ‘thrown further examples of corporate failure into sharp relief’.

Active equity funds were hit by large redemptions earlier in the year as market turmoil led investors to hasten their shift into passive funds; according to Mr Glyn sustainable funds have been ‘the one area of real strength for active equity funds’ adding ‘[ESG] is great for the [fund] industry because it’s active money that comes with higher fees, plus it’s something that investors want’.

Calastone samples mainly UK-based funds, but elsewhere, Morningstar reports that ESG fund flows represented almost a third of all European fund sales in Q2; sustainable equity funds gathered 63% more new money than traditional equity funds.

According to Calastone sustainable funds accounted for one-third of flows into global equity funds over the past year, rising to more than half in June and July.

ESG funds’ performance was bolstered by their low exposure to oil and gas which allowed them to outperform the wider stock market during the sell-off, although Morningstar reports that the majority of sustainable funds have beaten traditional funds regardless of this year’s exceptional market conditions.

A factor in the continued attraction of ESG will be the agreement and adoption of clear ESG standards and the elimination of ‘greenwashing’ after it was recently revealed that twenty ‘sustainable’ funds invested in fast-fashion retailer Boohoo, which has been hit with very public allegations of poor working practices.

Actively Seeking to do Good; Passively

If active managers are buoyed at the prospect of investors taking the opportunity to ‘build back better’ and their potentially greater ability to engage with investee companies, a recent survey by Invesco suggests that their joy may be short-lived as ESG ETFs surge in popularity.

Invesco’s survey of 101 European institutional investors found that currently just 21% of ESG investments by pension funds, mutuals and insurance companies are made via passive funds; however, 45% said they planned to increase the amount they invest in ESG ETFs in the next two years, with just 5% saying they planned to cut passive exposure.

At present, just $2tn-$3tn of the $32tn invested in ‘sustainable’ strategies is done so passively, but the survey found that more than half of the investors believe the majority of their ESG investments will be managed passively within the next five years.

Gary Buxton, head of ETFs and indexed strategies at Invesco said: ‘For the growing number of investors looking for funds with ESG considerations, it is clear that ETFs are playing an increasingly central role in helping them gain exposure’. He said that while investors were first attracted to ETFs due to their low costs and simplicity, ‘as we have seen so far this year, ESG ETFs have also been able to deliver on performance objectives’.

The S&P 500 ESG index, for example, has risen 6.6% eclipsing the 4.4% return of its traditional underlying index; net inflows to ESG ETFs in first six months of 2020 total $32bn, more than three times the $10bn inflows in the same period last year.

The range of ESG ETFs is growing with funds that exclude companies in undesirable industries or with poor ESG scores; Mr Buxton said that as people have come back into the market they have take the opportunity to re-evaluate how they do so, and ESG was at the front of the queue.

Invesco’s research also found that two-thirds of institutional investors believed the Covid-19 pandemic would accelerate the push into ESG in the next two years, with just 4% disagreeing; Mr Buxton said many institutional investors had already decided to increase their allocation to ESG in the past 18 months but had not done so, in part because of tax reasons.

Mr Buxton said Bloomberg data showed that in the first seven months of 2020, equity ESG ETFs in EMEA attracted net inflows of $13.9bn while traditional equity ETFs had seen net outflows of $7.7bn; there is a belief that companies in ESG are capable of long-term investment outperformance, that they are well run companies that have adapted to the future,’ he said.

Invesco forecasts that the assets of ESG equity ETFs will surge from $50bn to $300bn in Europe by the end of 2024, with corporate bond ESG ETFs also seeing rapid growth from a lower base.