Riding the ESG revolution

In my last post on fund research, I talked about thematic investments and mega-trends, and in many ways, the biggest mega-trend in investing at present is responsible investing in its various forms. It’s clearly an area that’s had a lot of coverage but I’m going to touch upon a few areas from the point of view of a fund selection team. So what do we mean by responsible investing? The Investment Association’s framework on this is a useful start – the two key areas for fund selection at the moment are ESG integration & stewardship and sustainable investment.
So what does that mean from a fund research perspective? For the ESG integration and stewardship perspective it means understanding how the funds we invest in approach this and particularly how ESG factors are considered within the investment process. From a sustainability perspective it is understanding how funds which label themselves as ‘sustainable’ are delivering this.
Let’s start off by talking about flows and performance. I saw a chart published by BlackRock recently showing the growth in ESG mandated funds, which is simply exponential. Between 2018 and 2019 assets almost doubled, and year to date through May, the value of sustainable assets had continued that upward inflection. I’m sure that growth will not come as a surprise to anyone, and it seems to me to be similar to the growth in passive over the past ten years, which I think most of us underestimated.
Turning to performance, we’ve long had discussions around whether there was some sort of trade-off between performance and investing responsibly. . Clearly styles come in and out of favour, but the recent period has largely been very positive for funds badged as having a sustainable investment approach.
Given many of these funds might be described as having a quality growth style, it’s really no surprise. That was by far the dominant style in 2019 and this year so far. So in the short to medium term, we can say that taking into ESG considerations into account has been a positive and nothing is being sacrificed from a performance standpoint.
It does raise one important point when we’re thinking about constructing portfolios though. One of the issues we find is that most funds in the space are naturally tilted towards quality growth, and whilst that’s a style we certainly favour today, finding managers that might provide balance is challenging. Companies sitting on the value side of the fence today would include some more controversial areas of investment, from an ESG perspective at least, such as energy, or perhaps poorly managed companies that the market has penalised heavily. Our view is that engagement with companies that show weak ESG scores is just as important in order to engender change, but there are certainly fewer managers tilted away from quality growth. Not unexpected, but nonetheless a challenge in a portfolio context.
So what are the challenges for a fund research team? There are really two elements. First, the challenge of assessing a whole new wave of funds in the space, which I’ll come to shortly. The bigger challenge however is assessing the ESG credentials of all our current managers, whether seeking to be seen as an ESG fund or not. It really is a sea change in terms of how we do our job. It’s fair to say that on both the fund research and asset management side of the fence there is a constant evolution.
We’re fortunate to have a number of tools to help us assess managers such as Sustainalytics data, and packages such as Style Analytics, which allows us to process the information. But there’s only so much the data tells you, so having a team of ten dedicated fund research analysts is really helpful in allowing us extra bandwidth to assess all this new information. Given how fast things are changing, whatever you thought you knew of a particular manager’s ESG process might have changed in the three or six months since you last saw them. We see a lot of new hires in the space, and inevitably most are doing their best to get up to speed as quickly as possible.
Green washing is another area often mentioned. We’ve met enough managers who I think you might accuse of over-egging their credentials, but at least to date it has been relatively easy to spot. Managers are getting more used to saying the right thing though, so I think it will become harder to spot the laggards going forwards.
The other challenge is the ever increasing number of new funds entering the market specifically focused on responsible investing. Many investors who buy into funds might be used to considering at least a three year track record and perhaps using screening methods to whittle down the number of funds.
Whilst there are funds with longer-term track records available, many of the newer options will not have a track record behind them. For some that might be a challenge, and one they are happy to pass on until they see results. Personally, I think in some ways it gets to the heart of what fund buyers should be doing – assessing managers on the merits of their proposed strategy, their edge, the resources behind them, and in some cases investing without necessarily having a full track record. It’s something my team has managed successfully in the past, so we’re comfortable with what will be a new challenge for some!
So that concludes this week’s blog. ESG investing is a space that is growing up fast, whether that is the approaches of fund houses, or even the mismatch between the main ESG ratings providers in terms of views. When it comes to researching funds, my view is that ESG represents a big challenge to investors and fund research teams in terms of knowledge, time, and indeed the availability and assessment of so many new processes and strategies, and that will only increase from here. Equally it is a great opportunity for those who get it right. Thanks as ever for listening in, and until next time, stay safe.

Written by

Nick Wood
Head of Investment Fund Research

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