New figures show investment flows into sustainable funds rose sharply in the three months to end of June. The pandemic has shone a bright and sometimes harsh light on how firms treat staff, manage supply chains and run their finances - and done the same to the conduct of governments.
The latest analysis from Morningstar shows that investment in sustainable funds more than doubled in the second quarter on account of surging interest and many new funds being launched under an ESG label.
Europe registered a record-breaking quarter with roughly $55 billion of new capital into ESG between April and June, bringing the total sustainabiliy holdings in Europe to close to $1 trillion, and the largest region by far for ESG investment. The last few months have spurred investors to consider what a multi-stakeholder approach looks like in light of the public health crisis. It has exposed everything from how companies treat their workers, manage supply chains to their conduct on dividends and share buybacks. No sector has come out unchanged by the tumult. Even lauded tech firms have faced more scrutiny from lawmakers and regulators seen in last month's Congressional grilling of US technology giants.
Morningstar mid-summer data also saw a sharp rise in the number of new sustainable funds. From March to July, Europe gained 107 new entries, with a quarter of these being in passive ETF products.
But all this momentum bears some inspection. Around a third of ESG-labelled funds are existing products that have been given a makeover over the last few years as sustainable investing has taken off. Around 600 traditional funds have been repurposed under ESG madates in Europe over the past decade, with 80 per cent of them receiving new credentials and new names in the last couple of years, according to those tracking such data. While there is nothing amiss, the tactic does show a rapacious instinct to get on board.
Another live issue has been ESG’s often cited ability to outperform the market during stressed times; and ESG equity indices have soundly outperformed their non-ESG peers in around 80 per cent of cases for the year so far. But this too comes with caveats.
Investors have fled to quality companies during this stressed period and these companies tend to already score high on ESG credentials as well-run corporations with strong balance sheets. Some of the strongest rated are in technology, a main beneficiary of the last six months of upheaval. In July, eight out of the 10 top-performing US large caps funds using ESG in their selection process had Apple (which just broke $2 trillion in market cap), Amazon or Microsoft as their biggest holding. They collectively hold around 20 per cent in high performing bigtechs. By the same token, these are funds generally less exposed to the energy sector, which has had a terrible time. So, more business as usual on the performance narrative.
New MiFID II suitability rules are also firing up ESG interest. These arrive next year and will require advisors to ask clients about their ESG preferences and match them to any future portfolio recommendations.
All this means that understanding how ESG data is applied to investment decisions is becoming a priority for advisors.
But grappling with performance data is not easy either. The main ESG ratings firms remain conspicuously adrift on how they rate companies and funds on their ESG performance, leaving fund managers to pick and choose the most favourable scores. Refinitiv typically uses a broader definition for ESG than rival Morningstar, for instance.
Firms that are developing their own in-house ESG research methodologies also tend to operate in opaque and confusing language, leaving investors no easy way of spotting greenwashing or avoiding being fobbed off. As much as the industry wants to standardize, the way companies report their ESG performance is still arbitrary and voluntary.
In this full swing towards ESG as a measure of genuine material risk in a depressed market that still has climate to deal with, it is up to individual investors to ask what methodology a fund uses and what the inclusion criteria are and make sure they understand the response.