It is estimated that globally there is now $31trillion invested under ESG mandates. ESG stands for Environmental, Social, and Governance. That means people have entrusted their savings to a fund manager who has specifically undertaken to incorporate ESG factors when building their portfolios. ESG investing is sometimes also called sustainable or ethical investing.
The Responsible Investment Association of Australasia (RIAA) estimates that 37% of all money professionally managed is now done so with some form ESG requirement.
In just in the past few weeks industry super fund REST settled a court case where they agreed to take ESG factors into consideration when managing their members savings.
Coinciding with this increase in consumer demand, returns on some ESG funds have been very strong recently, drawing investors to these options, even if they don’t hold strong convictions as to the underlying thesis.
Back in episode 42 – What is Ethical Investment all about? I covered the basic in the space.
In this post, we will take a look at why the performance of ESG funds has differed from the standard benchmarks, and the interesting variance across different ESG options.
It’s worth highlighting that nothing in this post should be considered investment advice. You should always seek out professional advice before embarking on an investment strategy to find solutions that fit with your needs and circumstances.
How have ESG funds been performing?
Ethical investing is very much in the DNA of my financial planning business – for several years the tag line on our logo was Bespoke Ethical Investment and I was involved with the Ethical Advisors Co-op. Today, we simply include ethical investment considerations as part of our standard process. As a result many of our clients invest in ESG options, and so it’s a space I follow closely.
Below I’ve complied a table comparing returns for the past 12 months of the largest ESG exchange traded funds and actively managed funds, against standard benchmarks.
|Returns for 12 months to 31/10/2020|
|Australian Stock Market||Global Stocks|
|Vanguard Australian Share ETF||-10.24%|
|iShares S&P500 (AUD)||3.95%||BENCHMARKS|
|Vanguard MSCI Global Share (AUD)||1.03%|
|FAIR – Betashares||-5.04%|
|ETHI – Betashares||9.42%|
|VESG – Vanguard||5.81%|
|ESGI – Van Eck||0.29%|
|BNP Paribas Environmental Equity Trust||12.42%|
|Stewart Investors Worldwide Sustainability||10.35%|
|Generation Global Share*||12.66%|
|Australian Ethical Australian Share||5.40%|
|Australian Ethical Emerging Companies||20.77%|
|*Not open to new investors|
My key takeaways:
- The benchmark return for Australian shares for the 12 months to 31 October was -10.24%. For ESG fund’s returns ranged from -5% to 5.4%. One fund that focused on emerging companies delivered almost 21%.
- The benchmark for global shares was a fraction over 1%. ESG funds ranged from 0.29%, so slightly worse than benchmark, to 12.66%.
- Synthesising these results, at least in the past year, applying ESG principles to your investing has been very helpful, and there’s a wide range of outcomes depending on which fund you choose, so diversification is important in this space.
Why the vastly different outcomes?
ESG returns differ from the standard benchmarks – that’s hardly surprising since the benchmarks will hold some stocks that ESG funds don’t – like fossil fuel companies. Because the ESG funds don’t hold some stocks, they end up holding more of others – technology and healthcare being the two main examples, and this year especially, those two sectors have been a good place to be.
A bigger question is why there is such difference amongst the various ESG offerings. Why does the ETF FAIR produce a return of -5%, while Australian Ethical’s Australian share fund, produces a positive 5.4% return? They’re both investing almost entirely in Australian shares (there are some small New Zealand expsoures), and both are using an ESG framework. So why such different outcomes?
This highlights the challenge for investors when investing in the ESG space. There is no consistent definition of what ESG investing is. It’s a bit like a farm being able to call itself organic, without there being any certifying body to verify that they are indeed doing what they say they will. The different approaches lead to vastly different investment portfolio’s, and these then translate into the broad range of investment returns you can see.
The best performing fund in this table is the Australian Ethical Emerging Companies fund. Australian Ethical screen out certain companies and industries, which is common in most ESG funds. But they also look for companies doing positive things in areas such as clean energy, healthcare, and sustainability. Many of these innovations are occurring in the small company space. The potential upside of smaller companies is typically larger, but of course so too is the downside. A BHP or CSL is never going to become worth zero, but a small medical research company could do.
In the larger cap, perhaps more traditional, space why did Australian Ethical deliver a 10% better outcome than FAIR? Clearly, the companies Australian Ethical held performed better over this 12 month period.
Australian Ethical is what is known as an active manager. That is to say they employ researchers, analyse companies, and build there portfolio’s based on the conclusions of this research.
In contrast FAIR is an ETF. ETF’s have a mechanical, computer driven approach whereby they replicate a given index, potentially with additional overlays applied. In the case of FAIR it uses both negative and positive screens – so companies in fossil fuel production and gambling are excluded, whilst companies that generate more than 20% of revenue from industries considered positive, like renewable energy and recycling, receive an increased weighting in the portfolio.
ETF’s are generally cheaper than active manager because they don’t have the expense of paying for researchers. Most analysis tends to find that ETF’s are the better way to go for investors as active managers often struggle to add enough value to justify their fees. However in the ESG space that may not be the case. Certainly over the past year, paying humans to do research and make decisions on where best to invest your money, has delivered significantly better returns.
In the global share space the value of active management was also seen with all 3 active managers outperforming all 3 passive ETF’s.
The lesson here is don’t be focused solely on costs when looking for ESG investment options. This is an area where human judgement appears to add value. Paying them half a percent extra to deliver you 10% or more extra return is a great deal.
In the global share space there is significant variation across the ETF options – from 0.29% to 9.42%. Why?
They both apply positive and negative screens. The specifics over these are clearly quite different though. ETHI is 72% US stocks and 39% Tech companies. ESGI is 36% US, exactly half, and it’s largest sector exposure is Healthcare at 22% of the portfolio.
For the ESG investor this highlights the challenge. Two investment options both with essentially the same promise. Yet the companies that your money gets put into are hugely different depending on which one you chose. ETHI, with its heavy tech focus has done well this past year as COVID has been a positive for the likes of Apple, NVIDIA, and Netflix. But who’s to say that won’t unwind in 2021? Maybe ESGI, with its more diverse portfolio – both geographically and by industry will fare better.
The ETHI portfolio hints at a key reason ESG funds have generally done well in 2020. They tend to be more heavily weighted to the technology sector, and to a lesser extent the health care sector, both of which have had stunning years due to COVID. It’s also been a good year to not hold oil stocks in particular, as fewer cars on the road has seen prices fall.
The unique aspects of 2020 have provided strong positive currents for ESG funds. But it would be unfair to suggest this is the only reason, or that it is a once off that we won’t see again. It can’t be denied that the world is moving towards more renewable energy. Slower than some would like, but it’s happening. And governments and citizens won’t be reducing their spending on healthcare anytime soon. ESG investing tends to put investors into sectors where there is some logic to long term growth.
RIAA found that over 10 years Australian share funds applying responsible investment practices produced an average 2.2% additional performance compared to the average across all comparable funds. For global shares responsible investment funds produced an additional 1% per year over 10 years.
ESG shone in 2020 because it had high exposure to the sectors that did especially well in COVID. But rather than view these results as a flash in pan, instead use it as bringing an opportunity to light that hadn’t previously been on your radar, because the long term numbers suggest that even beyond a COVID impacted world, ESG investing stacks up – just understand what the fund you chose will deliver.
This information is of a general nature only and has been prepared without taking into account your particular financial needs, circumstances and objectives. While every effort has been made to ensure the accuracy of the information, it is not guaranteed. You should obtain professional advice before acting on the information contained in this publication.
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