Sustainable funds coming of age: flows and performance

Jon Hale
Jon Hale
Jul 12 · 4 min read

U.S. investors poured a record amount of money into sustainable open-end and exchange-traded funds in the first half of 2019. As of early May, in fact, estimated net flows into sustainable funds had already surged past the calendar-year record of $5.5 billion. At the end of June, estimated net flows stood at $8.9 billion.

Why is this happening? For a while now, there has been a mismatch between investor interest, which is high and growing, and the ability of the financial-services industry to turn that interest into investments. But more financial advisors now appear to be willing to address investor demand.

One reason may be that more sustainable funds have developed long enough track records to make advisors comfortable recommending them.

The recent wave of sustainable fund launches began in late 2014, which means that those launched between then and June 2016 now have track records of at least three years. We all know that three years is a short and arbitrary time period to really discern much about fund performance over the long run, but many of us use it nevertheless as a minimum threshold.

How have the sustainable funds classes of 2014, 2015, and early 2016 fared after three years? The answer is — pretty well.

Funds earn Morningstar ratings (stars) after three years. The star rating is a risk-adjusted performance evaluation relative to category. Funds with risk-adjusted returns ranking in the top 10 percent of each category get 5 stars, the next 22.5 percent get 4 stars, the middle 35% get 3 stars, the next 22.5 percent get 2 stars, and the bottom 10 percent get one star.

As of the end of June 2019, based on their three-year annualized risk-adjusted returns relative to category, the distribution of stars for the 42 sustainable funds that have recently “come of age” is as follows:

Morningstar Rating as of 6/19 of U.S.-domiciled Sustainable Funds launched between 9/14 and 6/16. For mutual funds with multiple share classes, the share class with the most assets was used.

These results show pretty impressive initial performance from sustainable funds. In the overall universe, the number of 5-star and 1-star funds is about the same; among these sustainable funds, three times more are 5-star than 1-star funds. Or think of the distribution in thirds: In the overall universe, about one-third of funds receive 4 or 5 stars, about one-third receive 3 stars, and about one-third receive 2 or 1 stars. For these sustainable funds, the distribution is 43% top third, 38% middle third, 19% bottom third.

Another way to assess performance is by looking at how these funds’ three-year returns rank within their categories. Here, I’ve removed risk but am still controlling for it to some extent by comparing returns to category peers. I assigned the funds to quartiles based on their three-year annualized returns.

As of the end of June 2019, the three-year trailing annualized returns of the 42 sustainable funds that have recently come of age place as follows within their categories:

Nearly 7 of 10 of the newly of-age funds ranked in the top half of their respective categories.

Here are the 5-star funds out of the group:

Data through 6/19. Source: Morningstar Direct

And several others have 3-year trailing annualized returns that rank in their respective Morningstar category’s top quartile:

Data through 6/19. Source: Morningstar Direct

The funds listed in the two tables above attracted $350 million in assets during the second quarter.

Another driver of flows, and this is probably an even bigger factor, is that there are many more passive ESG options available than just a few years ago and their prices are falling. Two funds that just launched this year, iShares ESG MSCI USA Leaders ETF (SUSL) and Xtrackers MSCI USA ESG Leaders ETF (USSG), which both track the same index, have expense ratios of only 0.10%. Eight out of the 15 funds with the largest flows in the second quarter were passive equity funds. For more on this, see my related piece from earlier this week.

The ESG Advisor

Incorporating sustainability and impact into your investments

Jon Hale

Written by

Jon Hale

Global Head, Sustainable Investing Research, Morningstar. Views expressed here may not reflect those of Morningstar Research Services LLC. or its affilliates.

The ESG Advisor

Incorporating sustainability and impact into your investments

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