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29 Sep

ESG investing - entering the mainstream? pt.2

Our investment partners at FE, recently published a document on Environmental, Social and Governance - or more simply put - ESG investing. Theres no denying that society as a whole has placed much greater focus on positive ethical consumerism and business practice over the past few years - from the reduction in plastic use to the rise in demand for vintage and second-hand shopping. As the countdown clock was unveiled in NYC earlier this week, ticking down the years, days, hours, minutes, and seconds humanity has to take climate action, we thought now was the perfect opportunity to share FEs publication on ESG investing and explore the extent to which this is developing into a more mainstream investment strategy.

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One of the main issues affecting the area of ESG investments is that there has been no overarching set of regulations which explicitly set out what requirements an investment needs to meet to be marketed as ‘ESG’. As such it is difficult for investors, financial advisers, fund managers and fund distributors to compare investments in this area on a like-for-like basis. Up until recently many funds and investments simply self-certified themselves based on their own criteria.

One of the long-term criticisms of ESG investing is that investors must sacrifice returns for their principles.Any traditional investment theory tells you that limiting your potential investment universe is likely to increase volatility and reduce potential returns. But as the world turns away from fossil fuels and the collapse in the price of oil shows, traditional safe havens in the post-pandemic world do not necessarily provide the certainty that they once did. Data from FE Analytics provides a swathe of compelling evidence. Looking at several ethical funds which are both 5-Crown rated and in FE Investments’ ‘Approved List’, most have consistently outperformed their sector benchmarks, even during periods of downturn.

There is even a growing body of evidence to suggest that sustainable investments and sustainable funds are better equipped to navigate this new landscape. A report by Morningstar in 2020 found that in a competitive marketplace, 70% of sustainable funds launched within the last 10 years had survived, compared with just 45% of conventional ones. Crucially, the report revealed, the sustainable funds had outperformed their conventional counterparts in terms of generating positive returns.

One aspect to consider however is how much of these returns can be attributed to the ESG process or to the factors behind them. It could be argued that it is not ‘ESG’ investing that is responsible for driving strong returns, and quantitative investors would highlight that the ESG investment decisions taken will tilt portfolios to certain factors, causing them to become overweight in these areas and underweight in others. This is great news for investors if that factor performs well, or the non-ESG alternative has performed poorly (as has been the case with the collapse of oil in 2020), but this can’t be attributed to the ESG investing process. Suffice to say, should the price of oil rise again, factor investing will show that non- ESG funds have benefitted, while those with an ESG focus will have not.

Until the regulations are further refined, and data and reporting become more consistent, ESG investing still has something of a ‘wild west’ feel to it. Without clearly defined terminology and poor consumer understanding of what ESG means and some of its inconsistencies, there are bound to be instances where irregularities occur. In a market where investors, financial advisors and fund managers are reliant almost entirely on the information companies and securities provide about themselves there is, at the least, the risk of investments not accurately reflecting consumer values, and at the worst, instances of ‘greenwashing’ whereby companies actively mislead investors about the products they are offering. What is clear is that for ESG investing to serve everybody, investors need to carry out as much due diligence as possible on their financial products, while fund managers need to less readily accept what companies are telling them.

Despite the current market inefficiencies within the industry, ESG investing is clearly here to stay and will more than likely become the de facto position for the industry at large. The need for trusted and insightful information is needed now more than ever.

ESG investing - entering the mainstream? pt.1