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ESG ETFs increasingly meet twin demands of principles and profit


Environmental, social and governance (ESG) investing has seen enormous growth over recent years with assets pouring into socially responsible investing in all its forms. And, beyond that, new studies show that, where once you had to accept a smaller return for following your principles, now being principled might even enhance your portfolio.

Investing in ESG through the exchange traded fund route (ETFs) has enjoyed a similar ride, with latest data from Morningstar showing that ESG ETFs brought in a record EUR4.3 billion of net new money in the third quarter of 2019, with equity propositions gathering the lion’s share. Flows into ESG ETFs represented 17 per cent of the total net inflows for the European ETF market in the third quarter.

Over at data providers ETFGI, a similar story unfolded with data showing that ETFs and ETPs invested in ESG globally gathered net inflows of USD2.80 billion during September. 

Total assets invested in ESG ETFs and ETPs increased by 7.81 per cent from USD43.90 billion at the end of August to a record USD47.33 billion, according to ETFGI, with Europe dominating with the most ESG classified products available, followed by the US and the Asia Pacific region excluding Japan.

A recent study from Lyxor offers us evidence that ESG investors do not have to compromise on performance. A positive screening strategy based on ESG scores can raise the ESG profile of portfolios, without denting returns, the firm says. 

Lyxor’s figures show sustainable investment assets, including both actively and passively managed ESG funds, reached more than USD31 trillion at the end of 2018, up 34 per cent since 2016. This now represents a 39 per cent share of global professionally managed assets, Lyxor reports.

Their study was conducted in association with the Lyxor Dauphine Research Academy, as well as their in-house research team. Researchers Fabio Alessandrini and Eric Jondeau of the University of Lausanne, found that, based on an analysis of the past performance of a universe of stocks (represented by the MSCI All Country World index) during the period 2007-2018, a policy of exclusion based on companies’ ESG scores did not impact portfolio performance negatively.

The researchers also found that in most cases, using an ESG filter improved the performance of risk factor portfolios, even on a risk-adjusted basis. For example, excluding 50 per cent of firms with the lowest ESG ratings from a European equity size portfolio added 2.3 per cent per annum of return over 10 years, while removing 1.6 per cent of volatility.

And although the bulk of ESG assets are still actively managed, there’s evidence of a shift to index funds amongst ESG investors, Lyxor says. In Europe, for example, passive ESG fund assets have grown at a rate of 35 per cent per annum over the past five years, compared with 11 per cent for actively managed ESG funds.

More research from the French on the ESG and ETF subject comes from Lyxor’s parent bank Societe Generale. Their report ‘Shades of green – A review of Socially Responsible Investment (SRI) ETFs and 50 underlying benchmarks’ found that some SRI ETFs could be good options to replace traditional world, emerging market and Eurozone ETFs. However, by contrast, classic US equity ETFs remain more efficient than their SRI rivals.

The SocGen study found that excluding Impact Investing, Thematics ETFs and Factor ETFs, there are 90 different products available in the US and Europe in the SRI space, equating to 13.5 per cent of the long-only country/region equity ETF offer, cumulating at around USD26 billion in assets under management in aggregate at mid-August 2019.

The report notes that SRI has gained considerable traction in recent years, with an increasing number of investors motivated by non-wealth factors without sacrificing financial returns. 

“Against this backdrop, the question of reconciling financial performance and corporate social responsibility have taken centre stage,” the report says. 

Based on current ESG scores and ratings, most recent studies demonstrate that ESG is not yet a factor. Better ESG scores could change this picture in the future but, for now, ESG cannot be considered as a source of additional risk or performance, says Societe Generale.

“But nor can it be considered as hurting risk-adjusted returns. For this reason, it is possible to turn a traditional strategy into an SRI-oriented strategy at no additional cost. This has led to the creation of hundreds of SRI indices in the passive management space.”

SocGen found that some SRI ETFs offer higher risk-adjusted returns than traditional ETFs, together with competitive holding costs.

The investors searching for all this ESG filtered investment are varied across the whole range of investors but millennials are the major driver in the wealth sector. Interviewed for this report, Chris Mellor, Head of Equity and Commodity ETF Product Management, Invesco, comments on what he calls a societal change in investor approach to investing, driven by a recognition of the work of climate change activist Greta Thunberg, while others in the industry cite the impact of Blue Planet II, showing the physical effects of plastic pollution on the natural world.

Robo-Adviser Nutmeg’s offering in the ESG space reflects the changing nature of the investor as well. James McManus of Nutmeg says that both their client base and their staff wanted socially responsible investment, commenting that their clients wanted an investment in line with their personal values, just as they choose organic or free-range produce in a supermarket, they wanted the same thing in their investment choices. The result for Nutmeg, which invests entirely through ETFs, is over 8,000 socially responsible investment portfolios, with combined assets over GBP120 million, while McManus reveals that a fifth of new investments from our clients in 2019 have been into the socially responsible portfolios. 

The conclusion is clear. ETF investors want ETFs which offer an ESG approach. 

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