Ethical funds have been growing in popularity, with managers starting to address the demand
Once a niche area, sustainable investing has become one of the hottest topics in the investment world. It has also become a bigger trend in the retail sector as more people, particularly the young and women, care about the type of businesses they are investing in. They want their money to go to companies that operate responsibly, and offer sustainable goods and services.
Retail assets are growing
According to the latest Eurosif report, retail assets now account for more than 30 per cent of sustainable investments, compared with just 3.4 per cent in 2013.
Retail investors are also expected to increase their allocation to sustainable investments from 38 per cent of their portfolio today to 48 per cent within the next five years.
As retail investors become a more significant force in sustainable investing, asset managers are gearing up to respond to the demand.
The pace of sustainable fund launches in Europe has accelerated in recent years, reaching a record high in 2018, with close to 300 new products. There are now 2,500 environmental, social and governance funds available for sale, covering an ever-expanding range of asset classes and sub-asset classes, making it easier than ever to invest for sustainability and impact.
Most of these new funds aim to deliver a better ESG outcome than conventional offerings, typically by tilting towards companies with better sustainability profiles, and excluding or underweighting firms with poor sustainability profiles.
Examples include the Oppenheimer DAM Developing Markets SRI Equity fund, which invests in companies with high ESG scores in developing markets. The Liontrust GF Sustainable Future Pan-European Growth fund is biased towards companies providing or producing more sustainable products and services, as well as having a more progressive approach to the management of ESG issues.
Other new funds aim to achieve impact alongside financial returns. This is the case for the Montanaro Better World fund. It invests in companies whose products, services or behaviour are deemed to make a positive impact on society, and that are run with sound ESG practices.
On the passive side, the launch of aggressively priced ESG core exchange-traded funds by iShares and Legal & General represented something of a milestone.
The 12 new ETFs charge between 0.05 per cent and 0.2 per cent, making them cheaper than most non-screened rivals. This means that, for the first time, investors can buy a range of ESG portfolio building blocks without having to pay a premium for the privilege. Surely this must be one of the strongest signals that ESG investing is fast becoming mainstream.
The ETFs exclude companies that operate in controversial industries, such as tobacco, weapons and coal mining, in addition to those in violation of the United Nations Global Compact principles.
Sustainable funds performed well in 2018
Performance-wise, in a year marked by high market volatility and broad declines in equity and bond prices, ESG funds fared better than their peers in 2018.
The returns of 32 per cent of ESG funds landed in the top quartile of their respective Morningstar investment categories, and 62 per cent finished in the top half.
By contrast, the returns of only 17 per cent lagged in the bottom quartile. Looking at sustainable equity funds only, we found a similar pattern, with 30 per cent ranking in the top quartile and 19 per cent in the bottom.
Sustainable funds today pursue a large range of investment strategies from a style and market cap perspective, meaning their collective returns are not driven by unique sector weightings. What they share is the consideration of ESG factors, which leads them to companies that are managing environmental and social issues effectively, and have strong corporate governance practices.
These tend to be lower-volatility and higher-quality companies that hold up better during downturns.
However, over longer time horizons, we also found that ESG funds ranked more often in top quartiles within their investment category. These results are in line with the growing body of research that shows a positive link between ESG considerations and corporate financial performance.
The narrative around sustainable investing is changing fast. The old-fashioned notion that “doing good” always means sacrificing returns no longer holds.
This should further support the case for sustainable investing to become truly mainstream.
Hortense Bioy is director of passive strategies and sustainability research at Morningstar Europe