Amid scepticism, environmental, social and governance investments are on the rise, with some funds acting as launchpads for first time investors, writes Arun Kakar
Used as an umbrella term for smaller subsets including ethical, sustainable and impact investments, ESG refers to investing in companies whose non-financial performance indicators are geared towards sustainable, ethical and corporate governance issues such as managing carbon footprint and ensuring systems of accountability.
According to asset management firm Morningstar, there are now ten mutual funds and exchange-traded funds (ETFs) investing in emerging market stocks with ESG performance an explicit part of their mission. More than a quarter of the $88 trillion assets under professional management are now invested under ESG principles, according to a McKinsey study.
'We’re seeing a ratcheting up of supply and demand,' UBS chief investment officer for impact investment and wealth management, James Gifford, tells Spears. 'As we see more sustainable and impact investing strategies come into the market, it’s one of those megatrends that we’re seeing right across society.'
According to Gifford, this uptick comes thanks to growth in ESG-rooted sectors such as education, healthcare, fintech, and cleantech. Just this week, J.P Morgan and Black Rock announced an ESG indices to address a growing demand among bond investors looking to target emerging market issuers embedded in ESG practices.
'We are seeing very large fund managers both in the liquid and illiquid space step up and start delivering sustainable impact investing strategies,' adds Gifford. 'We will see more of those large mainstream private equity funds launching these strategies with very robust impact investment over the year.' According to UBS, 92 per cent of academic research shows that pools focused on ESG issues either outperform or are neutral with more traditional asset classes.
ESG is good news in the institutional investment space too, according to John David, head of Rathbones Greenbank, the firm's ethical investment arm. '[It] is becoming a more integrated part of good portfolio management.'
'We only have to look at historical examples where ignoring ESG factors have come at a very obvious financial price,' he adds, looking back to the Volkswagon emissions scandal, which resulted in a €1.6 billion loss, as a cautionary tale.
'There is an important distinction to be made between using ESG factors to manage risk and also using it [to work out] where opportunities come from.'
Increased transparency in supply chains can leave brands open to a new kind of public scrutiny. When even low income workers have smartphones, a scandal is only a Facebook message away from the front pages. Sustainability is not immune to intangible risks such as a reputational crisis.
Both David and Gifford think that ESG investment has not yet made it to the mainstream, but both are firmly confident that it will in the near future, thanks largely to younger investors.
UBS finds that around 69 per cent in the HNW/UNHW bracket say they want to align their investments with their social values. This comes as no surprise, as millennials have grown up with issues such as climate change and supply chain concerns playing a central role in their lives.
'People are starting to think about the experiential returns to the family of sustainable and impact investing,' says Gifford, who also educates younger UHNWs at Harvard and Zurich University on impact investing. 'Many of my students from wealthy families were not inserted into investment at all until they understood sustainable impact investing.
Most importantly, Gifford notices that most of his students start with sustainable impact funds. 'It’s a pathway for millennials to become effective stewards of family wealth.'
Gifford has seen UHNW millennials starting ESG sibling funds, where they work with a small allocation from the family office and learn the ropes of investing through. Sustainable funds might be 'more meaningful' to millennials, he says, but they can also bring portfolios closer to family values.
'What people are starting to think about is the experiential returns to the family of sustainable and impact investing,' he adds. 'Many of our clients actually have very well run and ethical businesses.
'This is now an opportunity for them to do the same in their investment portfolios and have that alignment of values, risk management and opportunity — the ESG argument comes not just across their business, but also their portfolio which is something that many clients hadn’t really thought about.'
Despite the favourable evidence, there still remains some scepticism among investors. A survey from the Financial Times last October found that over half of some 500 fund managers thought that ESG investments would lead to lower returns than in traditional pools.
Sceptics point to the rise of ESG funds and outperformance of their indices as a cyclical anomaly. Lower oil prices and the creaking commodities 'supercycle' might mean that traditional 'old stocks' are just out of style, not favour. There are fears that ESG will be exposed when traditional stocks are back in vogue.
'I don’t think these criticisms bear up to scrutiny,' says David. 'It’s highly likely over the short term that ESG or sustainability mandates will perform differently from their conventional peers or competitors, but I think that short term analysis is a little less relevant that longer term trends.
'There’s been plenty of good long term analysis of ESG investment performance that has seen us through various commodity cycles, where the performance isn’t negatively impacted by ESG criteria.'
Arun Kakar is a graduate journalist at Spear's