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ESG - The Future or a Fad?

ESG - The Future or a Fad?

ESG (Environmental, Social and Governance) has emerged as one of the most interesting and important investment trends over recent years.

Media coverage and interest in this investment theme seem to be gathering pace, but is this really going to be the driving force of a more conscientious market economy? A new flavour of capitalism?

Or is it simply the latest sales pitch dreamt up by clever marketers?

There is no doubt that concern about climate change and the environment has been rising.

Greta Thunberg and Extinction Rebellion have captured the public imagination.

However, the extremes of their agenda are unlikely to find favour with investors and traders.

Nonetheless, they want to be seen to be doing their bit, and investing with an ESG overlay fits that bill.

The ESG movement can trace its roots back over three decades or more, however, it’s only more recently that it has started to gain critical mass as an investment strategy.

Morning Star research conducted in August 2020 found that there were more than $1.0 trillion dollars in ESG focused investment funds, equating to around 13% of the total AUM in the fund management industry, a total of $71.0 bln dollars flowed into ESG funds during Q2 2020.

The vast majority of that money, $61.4 billion, came from European investor flows that Morning Star attributed to;

“ A greater experience of responsible investing and the favourable regulatory environment in Europe.”

At the end of Q2 2020, there were more than 2,700 sustainable funds that met ESG criteria and there were 125 new launches in the first half of 2020; 107 of those were passive trackers such as ETFs.

Within the research Morning Star identified 586 traditional funds that had been 're-packaged' into ESG funds, including 477 that had changed names to reflect their new mandates.

That’s where the problems start.

Because we have to ask ourselves...

Were those fund managers keeping an eye on their costs and recycling existing infrastructure in new fund launches or something more cynical?

With the managers just jumping on the latest buzzwords and trends that’s not an easy question to answer.

What about the performance of ESG as an investment style or theme?

Evidence is emerging that having an ESG agenda can improve investment returns.

MSCI published research in April 2020 showing that an ESG overly added a cumulative 1.88% to the performance of the top 20 ESG funds between 2009 and 2019 (compared to what would have been achieved without that bias).

What’s interesting is that the majority of those additional returns were generated between 2015 and 2019.

Name

ESG Rating

Quality Score

Carbon Intensity

3 Month

YTD

1 Year

3 Year returns

Technology Select Sector SPDR Fund

7.58

19.04

9.14%

30.66%

48.94%

26.43%

Invesco QQQ Trust

7.19

39.16

6.76%

34.37%

49.23%

25.06%

iShares Global Tech ETF

7.46

29.19

8.81%

27.93%

45.16%

23.11%

iShares U.S. Medical Devices ETF

7.70

23.31

8.18%

19.07%

31.15%

22.40%

iShares Russell Top 200 Growth ETF

7.32

30.06

8.38%

28.41%

41.70%

22.28%

Vanguard Mega Cap Growth ETF

7.36

43.36

8.36%

30.55%

43.72%

22.14%

Nuveen ESG Large-Cap Growth ETF

7.66

15.69

7.05%

26.09%

38.41%

22.09%

Pacer Trendpilot 100 ETF

7.17

39.12

7.60%

22.53%

35.91%

20.09%

Invesco Dynamic Large Cap Growth ETF

7.16

22.48

9.07%

22.76%

32.04%

16.88%

Invesco Cleantech ETF

7.68

54.89

17.60%

25.13%

39.91%

14.46%

iShares MSCI USA ESG Select ETF

8.29

112

8.56%

14.97%

24.99%

14.17%

First Trust Global Wind Energy ETF

AAA

10.00

774.26

16.92%

28.65%

40.68%

14.03%

iShares MSCI New Zealand ETF

AAA

10.00

112.28

5.59%

8.07%

17.92%

13.82%

iShares ESG Aware MSCI USA ETF

7.17

91.3

6.74%

11.65%

21.27%

13.76%

iShares MSCI KLD 400 Social ETF

7.62

110.73

6.15%

11.10%

20.60%

13.17%

Invesco S&P 500 Quality ETF

7.38

102.1

6.01%

9.10%

19.01%

11.97%

First Trust NASDAQ Clean Edge Smart Grid Infrastructure Index Fund

8.21

155.95

15.49%

24.38%

33.67%

11.81%

SPDR S&P Health Care Services ETF

7.37

24.28

14.31%

12.96%

29.21%

11.67%

Global X YieldCo & Renewable Energy Income ETF

AAA

9.35

6.60%

6.53%

13.66%

10.96%

iShares Global 100 ETF

7.76

64.63

2.61%

7.36%

16.75%

10.70%

iShares MSCI Denmark ETF

AAA

8.92

150.67

9.97%

27.47%

42.23%

10.60%

The table above shows 21 ETFs with an ESG rating of AA or higher and an ESG quality score above 7. The data is drawn from ETF.com and the ESG metrics are MSCI’s.

What we find is that there appears to be a correlation between higher ESG scores and three-year performance particularly when comparing the returns to those of SPY the S&P 500 tracker ETF, which has no specific ESG bias and a +13.13% three-year return profile.

But if we examine the table more closely we can see that the technology sector looms large over it.

The top three performers are tech-oriented ETFs and several other constituents are large-cap growth-oriented ETFs which will doubtless have the US tech giants in the portfolios.

This raises the question of just how much influence the ESG factor has played in these returns and whether it’s coincidental rather than causal.

Something we may only really get to judge as and when Technology and Growth stocks fall out of favour (if indeed they do).