Environmental, social and governance (ESG) investing is among the industry’s fastest growing trends, catching the attention of investors in a way that most other forms of active management have struggled to do for many years. But is this growing part of the market actually meeting investor outcomes?
According to Morningstar’s Sustainable Investing Landscape for Australian Fund Investors report for Q2 2021, assets in Australian sustainable investments were $33.42 billion as at the end of June this year – a 66 per cent increase compared with the same period in 2020.
These inflows have been underpinned by the retail investor who has been influenced by a number of issues. The Australian bushfires of late 2019 certainly put ESG investing in the limelight as the effects of climate change become front and centre of the national dialogue. The momentum in this growth continued with the onset of the global COVID-19 pandemic in 2020, a pattern that has continued into 2021.
The substantial growth in ESG investing highlights that retail investors are increasingly demanding better alignment of their values with their investment strategies. However, is this shift simply virtue signalling or are ESG investments really delivering outcomes for investors?
In some ways, the recent rise of ESG funds means it’s potentially too early to answer this question. However, our recently published paper, ESG Investments Improve Performance ... Or Do They?, aims to assess some of the myths around ESG investing and whether these strategies can deliver for investors.
Balancing risk and reward
There are 33 Australian-domiciled large-cap global equity funds with unique investment strategies which are tagged as sustainable investment funds, according to Morningstar data. Demonstrating how recent the growth in ESG funds is, only 19 of the 33 have a three-year track record, while just 14 of the 33 funds have a five-year track record as at 31 August 2021.
Certainly, over the last five years, we've identified that there has been no discernible increase in risk adjusted performance on average, but equally, there has been no discernible decrease performance from these investments.
However, looking at the same risk or reward analysis now over the shorter three-year period, results are slightly more encouraging as highlighted in the following chart.
The results are also encouraging for investors looking to build portfolios that are aligned with their personal beliefs without sacrificing returns.
Clearly there is demand from retail investors who now want their investment strategies to reflect their values. At the same time, the breadth of different approaches undertaken by funds, combined with differing methodologies for defining ESG, can make it very difficult to ascertain which funds are delivering an ESG proposition with the right investment outcome.
It’s important for advisers to get a better understanding of this sector while also having the tools and knowledge to help their clients choose the funds that are genuinely doing something different and are worth paying for.
Tim Murphy is Morningstar’s director for Manager Research Ratings, Asia-Pacific
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