Barita Insights: Weekly Newsletter January 4, 2020

Analyst Insights

The Backdrop
Throughout history, the social and economic issues shaping specific moments in time have evolved. For instance, the 19th century was characterized by the oil boom wherein oil refinement techniques were developed, and gasoline engines were created and were “all the rage”. Today, however, the long-term trajectory of the crude oil industry has become increasingly murky as governments globally push the envelope towards attaining carbon neutrality as sustainability becomes a necessity. Consequently, Environmental, Social and Corporate Governance (ESG) Investing has taken the spotlight.

ESG Investing is an umbrella term for targeted investment in companies that manage their carbon footprint and maintain a positive social and governance framework while delivering positive risk-adjusted returns. While this is not a new concept, in the past, investing based on ESG factors was believed to be tantamount to foregoing higher returns in non-sustainable areas of the investment landscape. In our view, however, the landscape has and will continue to change rapidly as governments priorities sustainability and incentivize, through policies, sustainable trends while deterring unsustainable ones. In this article we look at ESG funds; particularly the growth they’ve seen thus far, the tailwinds that will drive future returns and why ESG will be a major investment factor.

ESG Funds and COVID-19
According to a Morningstar report dated May 2020, ESG Funds (invest in companies that rank highly in ESG factors), were growing significantly pre-pandemic, doubling their collective assets over the last three years. More interestingly, the report noted that despite the pandemic, “Investors across the globe put $45.6 billion into funds focused on ESG in the first quarter of the year. This compares with global outflows of $384.7 billion for the overall fund universe.” In a more recent report by Morningstar (October 2020), the strong inflows into sustainable funds continue to increase with the September quarter (Q3) boasting a 19% increase over the prior quarter in new assets, pushing ESG fund assets to more than USD 1.2 trillion globally despite the pandemic.

ESG Fund Segmentation
At present, Europe accounts for the majority of ESG fund assets at 82.1%. This reflects the posture of European policymakers who have largely embraced a sustainable future far more than other developed countries. The US presently ranks second, accounting for just 14.2% of total ESG fund assets. Though small in comparison, the growth in ESG assets in the US has been phenomenal – by July of 2020, the net capital inflow into ESG Funds in the US outpaced all of 2019 and 2019 net inflow was actually 4x higher than in 2018. This growth was despite the US’ posture over the period which was largely anti-sustainable investing, which was consistent with the Trump presidency. With the advent of the Joe Biden presidency, however, the US is expected to realign itself with sustainability trends – carbon neutrality as the world fights climate change, increased care for social issues within organizations, etc. This, we believe, will provide added fuel to the significant capital inflow ESG funds have received.

A lot of runway for ESG Fund Growth
In addition to the change in presidency and the continued global push towards sustainability, ESG funds have other major tailwinds. Firstly, despite the growth we’ve seen recently, ESG Funds only account for 1% of the overall US market which is just a drop in the bucket. Secondly, there’s a massive transfer of wealth on the horizon to the tune of US$30 trillion as baby boomers (56–74-year-olds) are expected to gradually transfer their wealth to their Gen X and millennial children. Why is this important? Well, based on a recent survey conducted by Morgan Stanley’s Institute for Sustainable Investing, nearly 95% of millennials are interested in sustainable investing, while 75% believe that their investment decisions could impact climate change policy. As indicated at the beginning, the social and economic issues which shape the times evolve. Consequently, while baby boomers did not care to invest their $30 trillion in these funds, their offsprings do, as these ESG factors will shape their futures and the future of their children.

Performance
Finally, the record inflow of capital into ESG Funds correlates not just with expectations for global sustainability measures taking the forefront, but also their performance. Essentially, sustainable funds have dispelled the notion that there’s a financial trade-off for investors who want to focus on ESG. One example comes from Morgan Stanley’s Institute of Sustainable Investing 2020 report which indicates ESG Funds had median returns that outperformed Non-ESG US Equity Funds (+2.8%) and Taxable Bond Funds (+0.8%) peers in 2019 and the first half of 2020 (Equity +3.9% and bonds +2.3%). Therefore, we believe that investors can derive long-term value by investing in ESG funds ahead of the real surge in global sustainability and sustainable investing.

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Written by Awah Muirhead, Senior Investment Strategy Analyst

Conclusions

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