Green is the new black as ESG buzz fuels inflows
The letters E, S and G have started to gain traction among investors in recent years as diversity issues and a Swedish teenage climate activist dominate headlines, showing how environmental, social and governance concerns have come to the forefront. This year has marked a turning point for ESG investments, with multiple fund launches and flows pouring into the strategy. It might be just the beginning.
Demand for such investments is surging as investors re-evaluate their global asset allocations, according to BNP Paribas. Money flowing into ESG funds has outpaced growth into both U.S. and European equity funds over the past 12 months, according to the bank. Stock allocation to ESG funds have increased sharply, while investors have also turned to green bonds in their search for yield. In fact, ESG equity funds are the second-most popular asset class after U.S. government bonds this year, with 28% of asset inflows, BNP Paribas says.
Luke Barrs, head of EMEA fundamental equity client portfolio management at Goldman Sachs AM, says ESG now forms a crucial component of fundamental analysis, which means companies need to adapt to increasing scrutiny from customers to ultimately become the source of long-term returns for investors.
So where are investors putting their money? Dutch and French stocks are generally preferred, with industrials and discretionary the most overweight sectors for more than 500 global ESG funds that own European stocks, according to Bank of America Merrill Lynch. The 10 most overweight names in ESG funds are: L’Oreal, Suez, Inditex, Geberit, Henkel, Novozymes, Veolia, Kerry Group, Axa and Orsted, BofA says. Their performance this year is diverse, but the majority show in-line or superior relative returns. That said, the analysts’ consensus isn’t particularly bullish. Orsted, a Danish renewable-energy pure play, was by far the best performer.
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Beyond ESG, Goldman’s Barrs says companies that provide innovative products that can help the shift toward greater global environmental sustainability should benefit from secular growth and demand tailwinds. He believes clean energy, water sustainability, resource efficiency, recycling and waste management, and responsible production and consumption could be attractive in the long term.
Europe is at the forefront of the overall trend. Sustainable investment assets in the five major markets of Europe, U.S., Canada, Japan and Australia/New Zealand stood at $30.7 trillion in 2018, with Europe representing almost half of the total, BofA said, citing the Global Sustainable Investment Alliance. The bank’s analysts estimates that investment into European equities by ESG funds will rise by as much as $1.2 trillion by 2030.
Demand for ESG strategies looks solid, and major asset managers like BlackRock, DWS, UBS, Nordea Bank, Credit Suisse and BNP Paribas have all started ESG funds this year.
“The single biggest focus we’re seeing both in terms of exchange-traded funds and more broadly across our business is responsible investing,” said Ian Ashment, head of systematic and index investments at UBS Asset Management. “It’s the number one topic we’re focusing on. There’s huge demand.”
Index providers are also taking note. The London Stock Exchange introduced two measures last month supporting sustainable finance in its markets, while MSCI started two provisional EU climate indexes in November, designed to meet the minimum standards for the EU Climate Transition benchmark and EU Paris-Aligned benchmark.
With Brisk money flows, the returns of so-called ESG Leaders benchmarks are starting to outperform — gaining about 3.4 percentage points more than European stocks over the past two years.
The biggest challenge when it comes to sustainable investing is data measurability and availability. Quantifying E, S and G factors is a difficult task, especially when more than 80% of ESG information available at this stage relates to policy statements, rather than material or numeric metrics, Goldman’s Barrs says.
Bloomberg Intelligence analysts say it’s not so much “about E, S or G but about niches that differentiate asset managers.” The analysts say that in general, ESG tends to “provide a buffer during downturns, but fails to keep pace when the market heats up.”