End of Week Notes
Takeaways from a record year for sustainable funds in the U.S.
What comes next for ESG investing?
The number of sustainable open-end and exchange-traded funds available to U.S. investors grew to 392 last year, with 71 new fund launches and 25 existing funds repurposed. These funds attracted record net flows of more than $50 billion — nearly one quarter of all flows into stock and bond mutual funds in the U.S. — and seven in ten outperformed their Morningstar category average.
Those are among the findings in the latest “Sustainable Funds U.S. Landscape Report”, published this week. You can download the report here:
The universe has grown nearly fourfold over the past decade, most of that in the past six years:
Net flows in 2020 were TEN times what they were in 2018:
Seventy-five percent of sustainable equity funds outperformed their peers last year. Forty-three percent finished in their category’s top quartile versus only 6% in the bottom quartile:
Most sustainable funds receive Morningstar Sustainability Ratings of 4 or 5 globes, an evaluation that is category-relative and based on the ESG risk of portfolio holdings rather than the fund’s intentionality:
Proxy voting in support of ESG-related shareholder proposals is more of a mixed bag. My colleague Jackie Cook and I looked at a number of key ESG votes in 2020’s proxy season — proposals that garnered at least 40% support by shares voted. Among sustainable funds that voted on at least 10 of these, most exhibited strong support. But in terms of AUM, a number of funds with large asset bases from firms like BlackRock, Dimensional, and Vanguard opposed most of the key ESG votes.
I discuss this in the Landscape Report, but the more-detailed results of our study, including the level of key-vote support of every sustainable fund, are available in our report, “Sustainable Funds Proxy Votes Show a Range of Support for ESG Measures”, which you can download here:
Compare U.S. trends with those in Europe by downloading our “European Sustainable Funds Landscape”:
Some further thoughts
Now that investors have nearly 400 equity and fixed-income fund choices covering virtually every relevant subasset class, including actively managed and passive options, it is more easy than ever to construct entire portfolios using ESG funds.
On average, sustainable funds performed well in 2020, as they have, for the most part, over the past several years. But the first-quarter was the first time most sustainable funds have had to deal with a serious down market. And what we found out is that they were more resilient than traditional funds.
Why? Well, let’s acknowledge two things: One is that ESG funds typically had less exposure to fossil-fuel-based energy — the year’s worst performing sector — but many traditional funds have very little such exposure anymore either. Second, ESG funds tended to have plenty of exposure to tech and on-line retail and streaming services, which benefited from the pandemic, but then again, so did many other funds.
Beyond that, what most sustainable funds have in common is an emphasis on evaluating the ESG performance of companies and structuring their portfolios to favor better ESG performers. They do this in many different ways with differing levels of emphasis, but most diversified ESG funds do it. And those types of stocks outperformed in 2020. They are the quality-growth stocks of the 21st Century, which tend to be good all-weather performers and good performers over the long run. They might not do as well during raging bull markets or when certain areas of the market outperform, like traditional fossil-fuel-based energy (but then who wants to bet on that, these days?).
So performance was strong, and so were flows. What does it all mean, big picture?
- We know that individuals and institutions are increasingly concerned about sustainability. In a recent survey conducted for the World Economic Forum, 79% of American respondents agreed with the statement: “I want the world to change significantly and become more sustainable and equitable rather than returning to how it was before the COVID-19 crisis.”
- Based on their sustainability concerns, people want to make decisions whenever they can that will contribute to making the economic, social, and environmental systems within which they live more resilient and better functioning for everyone. This happens more frequently than ever in consumer decisionmaking.
- When it comes to investing, more people are realizing that their sustainability concerns can now be readily addressed through their investments.
- From the supply side, we now have ample numbers of ESG funds available. Their performance has mitigated concerns of financial advisors and intermediaries about investment performance. Financial advisors are increasingly willing to not only accommodate but to encourage ESG investing rather than warn against it.
What comes next?
- A growing focus on climate change — both in terms of investor demand for portfolios that clearly mitigate climate risk and for those that thematically pursue investment opportunities that will hasten the transition to a net-zero economy by mid-century.
- Impact will resonate more and more with investors who want to make a difference with their investments. I think we will see funds focusing more on demonstrating the broader societal impact of the companies they own or of the projects financed by the bonds they own. And, last but not least, funds must respond to growing expectations from investors to engage effectively with companies about ESG-related concerns and to support ESG issues in their proxy voting.
